Concept and Governing Character
A partnership is a contractual relation in which two or more persons bind themselves to contribute money, property, or industry to a common fund, with the intention of dividing the profits among themselves. The same juridical form may be used by two or more persons for the exercise of a profession, subject to the rules governing the profession and the continuing personal responsibility of the professionals for their own acts.
The partnership relation is founded on consent, contribution, a common undertaking, and profit-sharing. It is not created by status, blood relation, friendship, common ownership, or joint activity alone. The controlling idea is that the parties intended to carry on an undertaking as co-owners for profit, with each partner assuming the legal consequences of membership in the firm.
Partnership is consensual because it is perfected by agreement, subject to special formal requirements in particular cases. It is nominate because the Civil Code gives it a specific name and governing rules. It is onerous because each partner gives something, whether capital, property, credit, skill, labor, or industry, in exchange for rights in the common venture. It is principal because it can exist by itself, and preparatory because it is commonly the legal medium through which business or professional activity is conducted.
A partnership is also a relationship of personal confidence. The identity, capacity, solvency, skill, and integrity of each partner matter because every partner may affect the rights and liabilities of the firm. This element of mutual trust explains why a partner cannot make another person a partner by merely assigning his interest, why admission of a new partner requires consent, and why death, insolvency, withdrawal, or other changes in membership may have dissolving consequences.
Essential Requisites
The essential requisites of a partnership are capacity to contract, a valid agreement, a contribution to a common fund, a lawful object or purpose, and an intention to divide profits. The absence of any essential element prevents the creation of a true partnership, even if the parties use the label "partners" in casual speech.
| Requisite | Legal Significance |
|---|---|
| Plurality of parties | There must be at least two persons because partnership is a contract and a relation among members. |
| Capacity | Each partner must be legally capable of entering the contract and assuming the obligations of the relation. |
| Contribution | Each partner must contribute, or bind himself to contribute, money, property, or industry to the common undertaking. |
| Common fund or undertaking | The contributions must be placed in a juridical or economic venture distinct from the separate affairs of the contributors. |
| Lawful object | The partnership purpose must not be contrary to law, morals, good customs, public order, or public policy. |
| Intention to divide profits | The parties must intend to share the profits of the venture as principals, not merely receive compensation, rent, interest, or debt payment. |
Consent must be directed to the formation of the partnership relation itself. A person who merely lends money, leases property, sells goods, supplies services, or works for compensation does not become a partner unless he also agrees to participate as a co-owner of the undertaking for profit.
The contribution may be money, tangible property, intangible property, credit, or industry, depending on the agreement and the nature of the venture. A capitalist partner contributes money or property. An industrial partner contributes labor, skill, service, or industry. A partner may be both capitalist and industrial if he contributes both capital and services.
The object must be lawful and for the common benefit or interest of the partners. A partnership formed for an unlawful purpose is void, and the law treats the profits and instruments of the unlawful undertaking according to the consequences attached to illegal contracts and prohibited activities.
Form, Registration, and Validity
As a general rule, a partnership may be constituted in any form because the contract is consensual. The use of a written instrument is not always essential to existence, although written terms are often necessary to prove the agreement, define management rights, fix profit and loss sharing, and protect third persons dealing with the firm.
When the partnership capital reaches the statutory threshold and consists of money or property, the Civil Code requires the contract to appear in a public instrument and to be recorded with the Securities and Exchange Commission. Non-compliance with this recording requirement does not by itself prevent liability of the partnership and the partners to third persons, because persons who deal with the firm should not lose protection merely because the partners failed to observe a registration duty.
A stricter rule applies when immovable property or real rights are contributed. The partnership contract must be in a public instrument, and an inventory of the contributed immovables or real rights must be made, signed by the parties, and attached to the public instrument. Without this required inventory, the partnership is void as to that contribution because the law demands certainty in transactions affecting real property.
Registration does not convert a partnership into a corporation. A partnership remains governed principally by the Civil Code and by the agreement of the partners, while a corporation owes its existence to a special statutory grant and operates through centralized corporate organs. The practical difference is that partnership liability, management, transferability, and dissolution remain tied closely to the persons of the partners.
Separate Juridical Personality
A partnership has a juridical personality separate and distinct from that of each partner from the moment of its constitution. It may acquire and possess property, incur obligations, sue and be sued, and act through partners or authorized agents within the scope of the partnership business.
The separate personality means that partnership property belongs to the partnership as an entity and not to the partners in their individual capacities. A partner has rights connected with partnership property, but his transferable economic interest is principally his share in profits and surplus, not a specific personal ownership over each asset of the firm.
The entity concept also means that partnership debts are debts of the partnership. Partnership assets are primarily answerable for partnership obligations. After partnership property is exhausted, partners may become personally liable according to the nature of the obligation and the governing Civil Code rules.
Separate personality does not erase the personal liability of partners. In an ordinary general partnership, partners may ultimately answer with their separate property for firm obligations, unlike stockholders whose exposure is generally limited to their corporate investment. The partnership form therefore combines entity personality with partner-level liability.
A partnership may act only through natural persons. Acts of a partner apparently carrying on the usual business of the partnership may bind the firm when done within actual or apparent authority. Acts outside the ordinary course require authority from the other partners, because a partner's agency is tied to the business for which the partnership was organized.
Partnership Property and Partner's Interest
Property brought into the common fund, acquired by the partnership, or held for partnership purposes is partnership property. The controlling consideration is not always the name appearing on the document of title, but whether the property was acquired with partnership funds, for partnership purposes, or under circumstances showing firm ownership.
A partner is not a co-owner of specific partnership property in the ordinary sense. He cannot treat a firm asset as his separate property, dispose of it for personal purposes, or subject it to attachment by his personal creditors as if it were individually owned. His personal creditors generally reach only his economic interest in the partnership, subject to the rights of the partnership and the other partners.
The partner's interest consists of his share in the profits and surplus. This interest may be assigned, but the assignee does not automatically become a partner. The assignee receives the assignor's economic rights but does not acquire management rights, access to confidential partnership affairs, or the status of a partner without the consent required for admission.
Rules for Determining Existence
The existence of a partnership is determined by the substance of the relationship, not by labels alone. The parties may call themselves partners without creating a partnership if the legal elements are absent, and they may create a partnership even without using the word "partnership" if their agreement and conduct satisfy the legal requisites.
The receipt of a share in profits is strong evidence of partnership because profit-sharing is a defining element of the relation. The inference is not conclusive, because a person may receive profits in another legal capacity.
- Co-ownership or co-possession of property does not by itself establish a partnership, even if the co-owners share benefits from the property.
- Sharing gross returns does not by itself establish a partnership, because gross receipts may be divided without sharing the risks and net results of the enterprise.
- Receipt of profits as payment of a debt does not make the creditor a partner.
- Receipt of profits as wages, salary, commission, or employee compensation does not make the employee a partner.
- Receipt of profits as rent does not make the lessor a partner.
- Receipt of profits as an annuity to a surviving spouse or representative of a deceased partner does not make the recipient a partner.
- Receipt of profits as interest on a loan, although varying with business profits, does not by itself create partnership.
- Receipt of profits as consideration for the sale of goodwill or other property does not by itself make the seller a partner.
The decisive inquiry is whether the alleged partner assumed the position of a principal in the business. A creditor, employee, lessor, seller, or beneficiary may receive money measured by profits without having the right to manage, the duty to contribute, the obligation to bear partnership consequences, or the intention to join the common venture.
Participation in management is important evidence but is not always indispensable, because partners may agree that management will be entrusted to one or some of them. Conversely, operational control alone is not conclusive, because an employee, agent, manager, or trustee may exercise control without owning the business as a partner.
Fiduciary Nature and Mutual Agency
Partners owe one another duties of loyalty, good faith, fairness, disclosure, and accounting. The partnership relation is fiduciary because each partner may affect common property, bind the firm, obtain business opportunities, and influence the distribution of profits and losses.
A partner must account for benefits derived from partnership transactions, use of partnership property, or opportunities connected with the partnership business. He may not secretly profit at the expense of the firm, compete in a manner inconsistent with his obligations, or appropriate business advantages that belong to the partnership.
Unless otherwise agreed, every partner is an agent of the partnership for the purpose of its business. An act apparently carrying on the usual business of the partnership binds the partnership when performed by a partner, unless the partner had no authority and the person dealing with him knew of the lack of authority.
Ordinary matters connected with partnership business may generally be decided according to the agreement of the partners and, in the absence of a controlling agreement, by the applicable default rules on partner participation. Fundamental changes, acts outside the usual business, admission of new partners, and alterations of essential terms require the level of consent demanded by the partnership agreement or by law.
Profits, Losses, and Liability
The partners may stipulate how profits and losses will be shared, subject to the prohibition against excluding a partner completely from any share in profits or losses where such exclusion would destroy the essence of the relation. A stipulation giving one partner all the profits or exempting one partner from all losses may be invalid when it converts the arrangement into something inconsistent with partnership.
In the absence of agreement, capitalist partners share profits in proportion to their capital contributions, while an industrial partner receives a just and equitable share based on the circumstances. Losses, in the absence of agreement, are borne by capitalist partners according to their contributions, while an industrial partner is generally not charged with losses as among the partners because his contribution is labor or industry.
The internal rule on loss sharing does not necessarily defeat the rights of third persons. A partner who is made liable to an outside creditor may have rights of reimbursement or contribution within the partnership according to the agreement and the law, but internal arrangements cannot be used to prejudice persons who validly dealt with the partnership.
Partnership obligations must first be satisfied from partnership assets. If those assets are insufficient, the partners in a general partnership may be required to answer from their separate property in the manner provided by law. This personal exposure is a central distinction between a general partnership and a corporation.
Wrongful acts, omissions, or breaches of trust committed by a partner acting in the ordinary course of partnership business, or with authority of the other partners, may produce firm liability. The rule protects third persons who deal with or are injured by the business as conducted through its partners.
Partnership by Estoppel
Partnership by estoppel arises when a person, by words or conduct, represents himself or consents to being represented as a partner, and a third person relies on that representation in giving credit or entering a transaction. The rule prevents a person from denying partner-like liability after inducing another to act on the belief that he stood behind the firm.
The doctrine does not necessarily create a real partnership among the supposed partners. Its main effect is liability in favor of third persons who relied on the holding out. There may be no true partnership inter se, no common fund, no genuine profit-sharing agreement, and no full set of internal partnership rights, yet the represented person may still be liable as if he were a partner to the relying third person.
Estoppel liability requires representation, reliance, and a transaction affected by the representation. Mere rumor, unauthorized use of a name, or unilateral assumption by a creditor is insufficient if the alleged partner did not hold himself out or knowingly permit the holding out.
Kinds of Partnership
Partnerships may be classified according to object, liability, duration, legality, publicity, and the nature of the partners' contributions. These classifications matter because they affect authority, liability, dissolution, transferability, and the rights of third persons.
| Classification | Kinds | Basic Effect |
|---|---|---|
| As to object | Universal or particular | A universal partnership covers all present property or all profits, while a particular partnership is formed for determinate things, a specific undertaking, or a particular profession or business. |
| As to liability | General or limited | In a general partnership, all partners are generally personally liable after partnership assets are exhausted; in a limited partnership, limited partners may enjoy limited liability if statutory requirements are observed. |
| As to duration | Fixed term, particular undertaking, or at will | A term or undertaking limits the contemplated life of the firm, while a partnership at will may be dissolved by a partner's will subject to good faith and liability for wrongful dissolution. |
| As to disclosure | Open, secret, or by estoppel | Disclosure affects the expectations of third persons and may affect liability where a person permits himself to be held out as a partner. |
| As to contribution | Capitalist, industrial, or capitalist-industrial partners | The nature of contribution affects profit shares, internal loss sharing, management expectations, and obligations not to compete. |
| As to purpose | Business or professional | A business partnership pursues commercial profit, while a professional partnership is a vehicle for the joint exercise of a profession subject to professional responsibility rules. |
A universal partnership of all present property contemplates contribution of property presently belonging to the partners and the profits obtained from it. A universal partnership of profits generally covers what the partners may acquire by their industry or work during the partnership and the usufruct of their present property, but not ownership of property acquired by inheritance, legacy, or donation unless agreed within legal limits.
A particular partnership is the more common form in business practice because it is directed to a specific enterprise, line of business, transaction, property, or profession. The scope of the particular partnership limits the apparent authority of partners and helps determine whether an act is within the ordinary course of the firm business.
A limited partnership requires compliance with the governing statutory formalities and a distinction between general partners and limited partners. General partners manage and bear general liability. Limited partners contribute capital and generally avoid liability beyond their contributions if they do not take part in control in a manner that misleads third persons or defeats the statutory conditions for limited liability.
Capacity and Persons Disqualified
Persons who cannot validly bind themselves by contract cannot become partners in the full legal sense. Minors, incapacitated persons, and persons acting beyond legal authority cannot be made to assume partnership obligations merely by being named in a firm arrangement.
Juridical persons may become partners when their charters, governing laws, and internal approvals allow the undertaking. A corporation that enters a partnership must act within its corporate powers and through proper corporate authority, because partnership participation may expose it to obligations beyond a simple investment.
Persons prohibited from giving each other donations or advantages cannot enter into a universal partnership with each other. The rule prevents parties from using a universal partnership to accomplish indirectly what donation rules prohibit directly.
Firm Name and Dealings with Third Persons
A partnership may adopt a firm name under which it transacts business. The firm name identifies the juridical entity to third persons and helps determine whether an act was done for the partnership or in a partner's separate capacity.
A person who allows his name to be used in a firm name or who represents himself as connected with the firm may incur liability to third persons under ordinary agency, estoppel, or partnership principles. The law protects those who rely on the apparent membership and credit of the firm in entering transactions.
Persons dealing with a partnership are generally entitled to rely on the apparent authority of partners acting in the usual course of business. However, third persons who know that a partner lacks authority, or who participate in acts plainly outside the partnership business without proper authority, cannot claim the same protection.
Dissolution as a General Incident
Dissolution is the change in the relation of the partners caused by any partner ceasing to be associated in the carrying on of the business. It does not immediately terminate the partnership for all purposes, because winding up may still be necessary to settle obligations, liquidate assets, collect receivables, and distribute surplus.
The possibility of dissolution reflects the personal and contractual nature of the partnership. Unlike a corporation, which generally has continuity independent of changes in stock ownership, a partnership is sensitive to changes in membership, authority, trust, solvency, and agreement.
Basic Tax Characterization
For income tax purposes, an ordinary business partnership is generally treated as a corporation and taxed as a separate taxable entity. This tax treatment is distinct from, but consistent with, the partnership's separate juridical personality under civil law.
A general professional partnership is treated differently. It is generally not taxed as a corporation on the income derived from the practice of the common profession; instead, the partners are taxed on their distributive shares, whether actually distributed or constructively received under the tax rules.
The tax classification does not control the civil law existence of the partnership. A firm may be a partnership under the Civil Code because the elements of the relation are present, while its tax treatment depends on whether it is an ordinary business partnership, a general professional partnership, or another arrangement specifically governed by tax law.