Forming a General Partnership in Texas

When Is a General Partnership Formed Under Texas Law?

Forming a General Partnership

There is much confusion over the law governing the formation of general partnerships in Texas. The Texas Revised Uniform Partnership Act, which was codified in the current Texas Business Organizations Code, attempted to provide a fresh, simple, and ultimately practical approach. However, Texas courts continue to mess up the analysis by reading the statute through the lense of the old common law. A recent Fifth Circuit opinion, Derrick Petroleum Services v. PLS, Incorporated,  659 Fed.Appx. 748 (5th Cir. 2016), is a case in point. If the opinion accurately describes the record, then the conclusion reached that no partnership was created seems profoundly wrong.

History of Partnership Formation Law

Historically, Texas common law recognized two virtually identical legal entities: general partnerships and joint ventures. The creation of these entities was determined by the presence of four elements: (1) mutuality of interest, (2) mutuality of control, (3) sharing of profits, and (4) sharing of losses. The elements were the same for both business forms, and all four had to be present. The distinction between the two was usually given as a practical, not legal, difference. General partnerships were usually thought to involve the entire business relationship of all partners, while joint ventures were usually for a limited purpose. The distinction only became significant when the dispute involved usurpation of opportunities. Joint venturers were owed each other no duties with regard to opportunities outside the scope of the joint venture, while general partnerships were usually held to encompass a broader scope of duties. The Texas legislature passed the Texas Uniform Partnership Act, which expressly rejected the common law as to the requirements for a formation of a partnership. Afterward, courts reasoned that the formation of a general partnership was governed by the Act, but that the four common-law elements determined the existence of a joint venture. However, in practice, courts continued to rely on the four elements for the determination of the formation of a partnership.

Next, the legislature adopted the Texas Revised Uniform Partnership Act. The intent of the current law was to get away from the elements altogether and focus on the nature of the relationship. The definition of a partnership under the current law is "an association of two or more persons to carry on a business for profit as owners creates a partnership, regardless of whether: (1) the persons intend to create a partnership; or (2) the association is called a 'partnership,' 'joint venture,' or other name." Tex. Bus. Orgs. Code Ann. § 152.051. A fair reading of the statute would be that the law of joint ventures was completely subsumed into the new partnership statute. A joint venture is a partnership, and the question of whether a partnership exists is whether the parties associated to carry on a business for profit as co-owners of the business. The intent to create a "partnership" is immaterial. What the parties named the entity or how they characterized it is immaterial.

Derrick Petroleum Services Opinion Gets Partnership Formation Wrong

In Derrick Petroleum Services v. PLS, Incorporated, Derrick Petroleum services had created a database of oil and gas transactions. That company entered into a "joint venture," pursuant to a written memorandum of understanding (MOU), with PLS, Incorporated. The two companies associated to carry on a business for profit, namely the joint marketing of subscriptions to the jointly branded "Derrick/PLS Oil & Gas Mergers & Acquisitions Database." Derrick contributed the existing database and its services in maintaining and continuing to compile the database. PLS contributed its services in marketing the database and selling subscriptions. The MOU called for the creation of a limited liability company to be owned by the two joint venturers after certain milestones were reached. However, the relationship deteriorated, the milestones were not reached, and the LLC was never formed. Both companies then sued each other claiming that the other had breached the MOU and to determine the ownership of the database. After a bench trial, the district court held that no partnership had been formed and that Derrick owned the database, while PLS had no rights in the database. The Fifth Circuit, in an unpublished per curiam opinion, affirmed--notwithstanding the court's repeated reference to the arrangement as a "joint venture."

Existence of the Partnership

The reasoning of the court was based on Section 152.052 of the Business Organizations Code governing "The Rules For Determining If a Partnership Is Created":

Under Texas law, a court considers five factors to determine whether a partnership exists:

(1) receipt or right to receive a share of profits of the business;

(2) expression of an intent to be partners in the business;

(3) participation or right to participate in control of the business;

(4) agreement to share or sharing: (A) losses of the business; or (B) liability for claims by third parties against the business; and

(5) agreement to contribute or contributing money or property to the business.

Derrick Petroleum Services v. PLS, Inc., 659 Fed. Appx. 748, 750–51 (5th Cir. 2016)

The court noted: "Proof of all factors is not required, but there must be sufficient evidence showing that, based on the totality of the circumstances, the factors indicate that a partnership was created." Id. at 751. The court held that no partnership was created because "only two of the five factors—expression of an intent to form a partnership and contribution of property—were present to only a limited extent." Id. Thus, the court treated the "five factors" as being similar to the old common-law elements, albeit without requirement that all the elements be present.

The court's reasoning simply does not comport with the statute. The legal issue of the existence of the partnership is the definition of an association to carry on a business for profit as co-owners, which the facts stated by the court plainly indicate was the situtation. The court does not reference the definition of a partnership and ignores the statutory language describing the five factors: "Factors indicating that persons have created a partnership include..." In other words, the five "factors" are a non-exclusive list of what is relevant to the existence of an association to carry on a business for profit as co-owners of the business. Furthermore, there is abundant case law dealing with the legal relationship of promoters who come together for the purpose of forming a corporation. Uniformally, courts hold that during the period prior to the formation of the corporation (or if the corporation was never formed), the relationship of the promoters in working toward the formation of the corporation is one of a general partnership, and such promoters are jointly and severally liable for obligations incurred during that period (unless ultimately assumed by the corporation if it is formed).

Ownership of Partnership Property

Having determined that the "joint venture" formed by the companies was not a partnership, and without telling us legally what the relationship was, the court then determines the ownership of the database. Section 152.102(c) does create a presumption that property purchased by a partner with his own funds remains that partner's individual property, even if used in the partnership: "Property acquired in the name of one or more partners is presumed to be the partner's property, regardless of whether the property is used for partnership purposes, if the instrument transferring title to the property does not indicate the person's capacity as a partner or the existence of a partnership, and if the property is not acquired with partnership property." The court holds that "MOU lacks any language clearly indicating the parties' intent to transfer the ownership of the database to the joint venture or PLS."  659 Fed. Appx. 748, 752. The court notes that the MOU required Derrick to "provide" the database to the joint venture, but not necessarily to transfer ownership. That conclusion makes some sense, but results in a grossly unfair result. Had the court held that a partnership was created and that winding up had been triggered by the conduct of the parties, then Derrick would have been entitled to keep the value of the database, at least as it existed at the inception of the partnership. However, the court's conclusion was that Derrick was entitled to keep not only the value of the database at inception, but the value of its services in maintaining and building the database during the operation of the joint venture, plus the value of PLS's services in marketing the database (and any subscriptions that PLS had been able to sell). PLS provided its marketing services to Derrick for no compensation, and Derrick provided nothing to PLS because Derrick merely improved the value of its own property in which PLS had no interest and from which it received no benefit. At a minimum, under the legal determination of the court, PLS should have been entitled to a quantum meruit recovery for the value of its services. The opinion does not reveal whether that compensation was requested or awarded.