Points to Keep in Mind When Forming a Partnership
By Drew J. Couto, esq.
The vast majority of horses running today are owned by partnerships. Generally speaking, a partnership allows people who would not otherwise be able to afford to own and race a horse to enjoy the same thrills and experiences as those better able to afford horses on their own.
The law defines a partnership as an association of two or more persons who own or co-own a business for profit. The partnership can either be “general” or “limited”. Individuals in a general partnership share in the profits, are responsible for managing the business, and are personally liable for partnership debts.
A limited partnership differs in that it consists of one or more general partners, and one or more limited partners. Under the law, a limited partner is not bound by the obligations of the partnership. Limited partners contribute capital and share in the profits but take no part in management of the business, and, therefore, incur no liability with respect to partnership obligations beyond their contribution.
Typically, limited partnerships prepare lengthy, detailed agreements, spelling out the rights and fatties of all involved. General partnerships are a far more common form of horse ownership. However, unlike a limited partnership, general partners quite often do not prepare partnership agreements, or otherwise reduce the terms of their arrangement to writing.
Now, as a lawyer, I should be critical of the fact that partners rarely prepare formalized partnership agreements. However, I am not. In one sense it is refreshing to be involved in an industry where an individual’s work is truly their bond. Moreover, experience has taught me that despite what lawyers will tell you, detailed contracts and agreements rarely guarantee that problems, disputes, and most importantly, litigation can be avoided. Nonetheless, prudence does require that I suggest partners consider preparing formal partnership agreements, or at the very least, discuss and agree amongst themselves as to certain important recurring issues.
Although all owners hope never to be involved in a partnership dispute, it is good, sound business practice to have given consideration to and to have reached an agreement on the following issues.
Name of Partnership and Racing Silks
Many partnerships run under the names of the individual partners, while others run under a stable name. Occasionally, it becomes an issue among partners as to whose “colors” the horse will compete in on a given day. This simple but significant issue should be addressed from the start. If an agreement is difficult to reach, partners should consider rotating the “colors” under which a horse competes.
Terms of the Partnership
Like marriage, the term of a partnership varies, with some longer than others. The termination of a partnership is generally referred to as its “dissolution”. A partnership may exist for a specified duration, continue until death, or until one or more of the individuals decide to leave the partnership. Unless the proper arrangements have been made in advance, the decision to leave the partnership will not relieve one of ongoing liability for partnership debts and obligations.
Profits, Expenses, and Losses
The profits and losses of the partnership are shared among the partners in accordance with their percentage of ownership. However, each partner is individually liable for all debts and obligations if his/her partners are unable to contribute their share.
Fortunately, many trainers recognize that one owner’s involvement may be limited and often look only to that individual for their proportionate share of training expenses. However, the decision to do so is a courtesy, and nothing more. As a consequence, ascertain for yourself that your partner is one whom you can trust and who has the financial resources to fulfill their obligations as an owner.
Partners pay taxes for only those revenues they actually earn. They are not responsible for taxes incurred by other partners on their proportionate share of earnings. Nonetheless, all partners should be familiar with applicable IRS and State taxation regulations, including IRS Code Section, 704(c).
Given that the majority of owners are involved in this industry as business owners, a prudent owner must be vigilant of these tax regulations and limitations.
Although not always done, it is advisable for partners, either individually or collectively, to maintain “books” which accurately reflect income, expenditures, assets, and liabilities. These books may be essential to the determination of tax liabilities or disputes among partners. If the books are maintained collectively, every partner is entitled to inspect the books at anytime.
Where it is determined that one partner shall maintain the “books” on behalf of the partnership, it is advisable to issue periodic “accountings” of partnership financial affairs. The partners should agree that each accounting should be final and conclusive as to issues among partners 30 days after receipt. This agreement should prevent prolonged disputes over long past transactions.
Management and Authority
As indicated above, in a general partnership each partner must have an equal voice in the management of the partnership. By operation of law, each has authority to bind the partnership in the making of contracts or other arrangements. The partners are bound by fiduciary duties to one another not to encumber or sell the horse without complete agreement among partners. Generally speaking, a partner’s remedy against a third party who has provided services to the partnership is limited. However, with respect to the partner acting improperly, there are no such limitations other than those provided in bankruptcy.
Purchase Options on a Terminated Interest
Upon the death or withdrawal of a partner, a partnership is deemed to have “dissolved”. Unless agreed upon prior to dissolution, the partnership’s assets, in this case the horse, must be sold for fair market value, with each partner sharing in the proceeds in accordance with their percentage of ownership.
To avoid the need for a public sale, the partners can agree to the termination value of the asset prior to dissolution. In such cases, the agreement of the partners should provide that a partner or a number of the partners may acquire the interest of the other at a specified price. However, predicting an accurate, fair value of the horse is quite difficult and may arguably be unfair to the individual leaving the partnership.
So, consider all of the circumstances involved before making a decision as how best to value the partnership asset upon death or withdrawal of a partner.
Death of a Partner
As indicated above, a partnership is dissolved by the death of any partner. In most instances, when a partner dies, the remaining partners are obligated to sell the horse(s) at a public sale. As an alternative, partners may agree that the value of a deceased partner’s interest ca be ascertained by means other than auction. When doing so, partners should agree that the purchase pf a deceased partner’s share includes the assumption of any and all obligations or liabilities previously or prospectively arising from that interest. Likewise, they should insist that the surviving partners agree to “hold harmless” the deceased partner’s heirs and estate from all liability and obligations arising from the partnership.
In essence, by executing this provision a partner agrees to bind his/her estate to sell the horse to the other partners at a given price, or at a price to be determined by a mechanism established in the agreement.
Applicable Law and Venue
Given that many partnerships consist of individuals living in different counties, states, and/or countries, it is prudent to specify the law that will be applicable to any dispute among partners. In addition, the partnership agreement should specify the place where all disputes will be resolved. This is quite different that specifying the law to be applied.
Lastly, partners should consider and specify whether disputes among partners will be resolved through litigation or alternatively, through arbitration or mediation.
Obviously, this is not an all-inclusive list of the issues relevant to a partnership. The article is intended simply to identify certain common issues and concerns partners should discuss when forming a partnership.
There are several useful reference books available which address these issues in more detail. Most provide examples of partnership agreements. These books are useful, and informative, but do not completely negate the need to consult legal counsel and/or a proficient accountant. Obviously depending on the value of the horses involved, the number of partners, and/or the concerns of the individual partners, the cost of obtaining an appropriate partnership agreement will vary.
However, for those of you simply looking for a reference source or guidance, my I suggest the following publications:
Equine Legal Handbook
Gary R. Katz, Half Halt Press
Distributed by Equine Research Inc.
The Complete Guide for Horse Business Success
Janet E. English, CPA,
Distributed by Equine Research Inc.
Legal Aspect of Horse Farm Operations
James H. Newberry, Jr.
Distributed by University of Kentucky, College of Law
Law for the Horse Breeder
Kenneth A Wood
Distributed by Wood Publications, Inc.