Lender or Partner?
Suppose that your client comes to you and says that he started a business and received funds from another person. Your client thinks that the other person simply made a loan to the business. The other person thinks that the funds are a capital contribution to a partnership, which made him a partner in the business. As is frequently the case, there is no formal documentation setting forth the status of the funds. Your client cannot show you a promissory note establishing that the other person is a mere lender, but assures you that there is no signed partnership agreement either.
The question you have to answer is whether your client has a partnership even though he or she did not intend that result. In advising your client, you can look to the Court of Appeals’ recent decision in Herman v. Pickell, Case No. 325920 (Mich Ct App, April 12, 2016), which provides valuable guidance to the bench and bar.
The plaintiff in Herman provided the defendant with $50,000, which they both initially understood would give a 10% interest to plaintiff in the defendant’s business. This arrangement was in fact set forth in a letter from the defendant to the plaintiff, which stated that the plaintiff was a 10% silent partner in the business. While the defendant acknowledged that initially he considered the plaintiff to be his business partner, he later asserted that the partnership had since been dissolved and liquidated and that the entire $50,000 had been repaid. Of further note is that the defendant wrote the plaintiff a letter stating that he would retain 10% ownership until his “$50,000 loan is completely repaid” and the plaintiff subsequently responded by characterizing the funds as both a loan and an investment. The defendant claimed that he had only received half of his alleged investment and brought suit seeking, among other things, a declaration that under the Michigan Uniform Partnership Act (“MUPA”), he was a 10% partner in the business and entitled to his share of the liquidated value of the partnership’s assets. After a bench trial, the trial court ruled in the defendant’s favor.
The Court of Appeals started its analysis by noting the principle that “[f]or a partnership to exist, it must be shown by an agreement, since it is the intention of the parties that is of prime importance in ascertaining the existence of a partnership” (citing Le Zontier v Shock, 78 Mich App 324, 333 (1977)). The Court also relied heavily on the Supreme Court’s decision in Byker v. Mannes, 465 Mich 637, 646 (2002), aff’d 469 Mich 881 (2003), which interpreted MCL 449.6(1) of the MUPA as providing that “if the parties associate themselves to ‘carry on’ as co-owners [of] a business for profit, they will be deemed to have formed a partnership relationship regardless of their subjective intent to form such a legal relationship.” The Byker Court went even further, holding that a partnership could have been formed even if the parties were not “aware of their status as ‘partners’”. 465 Mich at 646. It also concluded that “in ascertaining the existence of a partnership, the proper focus is on whether the parties intended to, and in fact did, ‘carry on as co-owners a business for profit’ and not whether the parties subjectively intended to form a partnership.” Id. at 653.
On appeal, the Court of Appeals stated that the above-described letters supported the trial court’s finding that the funds were furnished in exchange for a 10% partnership interest. The Court also rejected the defendant’s argument that pursuant to MCL 449.7(4), his payments to the defendant were not distributions of profits, but rather repayments of “a debt by installments,” and hence not evidence of a partnership. The Herman Court based its holding on the defendant’s first letter, which it deemed to have defined the terms of the partnership, including repayment of the plaintiff’s funds, without having characterizing them as a loan. The Court also dismissed the defendant’s argument that the parties referred to the funds as a loan in subsequent letter, citing Byker’s holding that the parties’ subjective intent to create a partnership is not the determining factor.
Not all cases involving the issue of whether a partnership had been formed will have a paper trail like the one in Herman. However, the holdings in Herman and and Byker show that despite a party’s good faith belief that no partnership ever existed, the business will be characterized as such if the parties’ course of conduct, objectively viewed, shows that the funds at issue were treated as an investment and not as a loan.
For more information on this topic, please contact Ken Neuman at firstname.lastname@example.org.