Unintentional Partnership in Texas

Question: Can two or more persons create a partnership even though they did not intend to do so?

Answer: Yes, under certain circumstances.

   Generally, under Texas law 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.  Partnerships are governed by Chapter 152 of the Texas Business Organizations Code.

   What this means is that two or more people could in fact cause the creation of a partnership even though they did not intend on doing so.  The consequences of being partners is the fiduciary duty which arises between partners. The Texas Business Organizations Code also sets forth factors indicating that persons have created a partnership. These factors include:

(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.

Interestingly, an agreement by the owners of a business to share losses is not necessary to create a partnership.

   On January 31, 2020, the Texas Supreme Court held that parties can conclusively negate the formation of a partnership under Chapter 152 of the Texas Business Organizations Code through contractual conditions precedent. The condition precedent was that the “venture” would not come into effect until the respective parties’ board of directors approved the deal.  The boards of the companies never approved the venture and thus that one provision saved one of the parties almost half a billion dollars:

Texas Supreme Court upholds Court of Appeals reversal of FIVE-HUNDRED-MILLION-DOLLAR trial court verdict. In Energy Transfer v. Enterprise, the high court dealt with a clause that contained conditions precedent to forming a partnership. Enterprise and Energy Transfer, two of the top ten largest energy companies in the United States, sought to re-purpose an existing pipeline or build a new one to transfer crude oil south as opposed to north. The two companies expressly rejected creating a partnership until two conditions precedent were met: 1) execution of definitive agreements memorializing the terms and conditions of the pipeline transaction that 2) received approval from each party’s board of directors. Subsequently, when the companies failed to get shipping commitments to cover the potential costs of the pipeline, Enterprise ended talks with Energy Transfer. Enterprise would eventually go into business with ConocoPhillips. Energy Transfer, believing Enterprise and Energy Transfer entered into a partnership agreement, sued Enterprise claiming breach of fiduciary duty. (Fiduciary duty is putting the wellbeing and interest of the person for whom they are responsible above their individual interests; the duty commands exceptional loyalty of the party owing a fiduciary duty.) The trial court awarded Energy Transfer damages totaling $535,794,777.40. Enterprise appealed, and the Court of Appeals reversed the trial court’s ruling and found for Enterprise. As a result, Energy Transfer filed for review with the Texas Supreme Court. Enterprise continued to argue no fiduciary duty existed because no partnership was entered into between the parties. The Texas Supreme Court agreed. The Court, applying long-standing freedom to contract law, held that parties could require conditions precedent to the formation of a partnership notwithstanding the Texas Business Organizations Code’s five factor partnership test.

   It is the general rule that when an agreement provides a condition precedent to the formation of a partnership, it will not come into existence until the condition has been met. However, such condition precedent may be waived and, if the parties actually proceed with the business, they may be held as partners even though the condition precedent has not been satisfied.

   Chapter 152 is not the sole source of rules for determining partnership formation. The determination of formation of a partnership should “include” the five factors listed in the section. Those factors are not exclusive. Principles of law and equity supplement the statutory partnership provisions unless otherwise provided by this chapter or the other partnership provisions.

What should persons do when looking into a business venture?

   First, the parties should enter into a written agreement, which can be informal, clearly stating that the parties are contemplating a business venture, or exploring the feasibility of a business venture; and that despite negotiations with third parties, expenditures of funds towards investigating the venture, reimbursement or sharing of expenses between the parties, no partnership shall be created “unless …….” (clearly and specifically stated).

   That “unless” is the condition precedent.  The condition can be approval of a formal agreement by the board of directors of corporations, by the manager or managers of an LLC, or the signed agreement for the formation of a partnership.  The condition could be the enactment of a trade agreement with another country, or even a minimum price making up the subject matter of the venture, such as the price per bushel of corn must be “$$$” before any business venture shall be formed, or as simple as requiring the respective wives of the parties to approve the venture in writing.

   Make sure oral agreements are disclaimed and a provision that the parties disclaim any reliance upon any representation made by, or information supplied by, the other party, and waives any claims for fraudulent inducement.

Should you need help understanding the laws surrounding General Partnerships, please contact one of our Murray-Lobb Attorneys.

Sweeping Changes on the Horizon: Fiduciary Duty of Employers & Others Managing 401K Plans

The statute governing the conduct of plan sponsors and advisors to 401(k) plans is the Employee Retirement Income Security Act of 1974 (ERISA).  Section 404 of ERISA imposes a prudent man standard of care on the employer and other plan fiduciaries, comprised of five standards:

  • Duty of Loyalty – A fiduciary must discharge his duties solely in the interest of the plan participants. This means the fiduciary must avoid conflicts of interest when managing plan assets.
  • Exclusive Purpose Rule – A fiduciary must discharge his duties for the exclusive purpose of providing benefits or defraying reasonable expenses only. The plan must not pay excessive compensation to its investment and service providers.
  • Duty of Care – A fiduciary must discharge his duties with the care, skill, prudence and diligence under the circumstances then prevailing that a prudent man acting in a like capacity and familiar with such matters would use in the conduct of an enterprise of a like character and with like aims. This is also known as the “prudent expert” standard.
  • Duty to Diversify – A fiduciary must diversify the plan’s investments so as to minimize the risk of large losses, unless under the circumstances it is clearly prudent not to do so.
  • Duty of Obedience – A fiduciary must discharge his duties in accordance with the documents and instruments governing the plan insofar as they are consistent with ERISA.

ERISA in § 1113(1) provides that claims brought against fiduciaries under the Act must be brought within six years from the initial breach.

On February 24, 2015, the U.S. Supreme Court heard oral arguments in the case of Tibble vs. Edison International.  This was the first case involving litigation over excessive 401(k) fees heard by the Supreme Court.

The Plaintiffs sued Edison International (Edison) in the U.S. District Court for the Central District of California (district court) to recover losses from alleged breach of fiduciary duty in management of their 401(k) plan based on two theories: 1) that Edison violated certain ERISA provisions by participating in revenue sharing with the funds to offset plan costs (essentially using a portion of the revenue from the participants’ funds to pay administration costs); and 2) that Edison violated ERISA provisions by imprudent handling of plan investments.

The district court granted summary judgment for Edison noting that Edison initially chose the higher-fee retail-class mutual funds for plan investments more than six years before the claim resulting in the plaintiffs’ claim being barred by the ERISA limitations period.

On appeal to the Ninth Circuit, Tibble counsel argued a continuing violation theory proposing that Edison continually breached their duty of prudence by failing to identify on an ongoing basis alternative lower cost fund options for plan participants through 2007.  If this theory was accepted, the last breach would have been in 2007 resulting in plaintiffs’ claims falling within ERISA’s six-year statute of limitations.  The Ninth Circuit affirmed the district court’s ruling.  Tibble petitioned the Supreme Court which granted certiorari to review the case.

While the underlying claim asserts that Edison breached its fiduciary duty in the management of the employee 401(k) Savings Plan, a defined contribution plan sponsored by Edison, the Supreme Court limited review to the limitations issue.

Edison initially claimed it had no continuous duty, and those claims were barred by the six-year statute of limitations, but at oral argument both sides agreed that the duty to monitor was a continuing one. They disagreed on the scope of that duty.  Edison International contended it had no obligation to switch to the less expensive share class, because this was not the type of issue significant enough to warrant “full due diligence.”  The position of the plan participants was that Edison International, as a fiduciary for the plan, had an obligation to make changes that any prudent investor would, which included switching to the lower-fee share class, as part of its continuing duty to monitor investment options.

In response to Justice Kagan’s question as to what a trustee is supposed to do under the prudent person’s standard, Tibble counsel advanced a three-part standard: 1) look at performance on a regular basis, a periodic basis; 2) look at the expenses and determine if there is a cheaper way to get the same investment for less money that’s coming out of the beneficiaries’ assets; and 3) has there been an alteration in the fund management that one ought to look further into.

On the other hand, Edison counsel argued that ongoing, periodic monitoring for anything other than more significant changes such as change in value and risks of the investments is not required.  In response to his contention that all of the changes required to sell retail shares and buy new institutional shares creates disruptions that employees don’t like which is why the monitoring process is usually limited to looking for significant changes.  Justice Kagan was rather incredulous at this proposition by Edison when she observed that, for people who have invested in funds for 30 to 40 years, this would not be much of a disruption at all.  At another point in oral argument, Justice Roberts chimed in questioning how there could be investor confusion.  Justice Roberts proposed that one sentence saying we have been paying .3 percent, and by changing funds, now we’re paying .2 percent, will not have people running out screaming that they’re confused about it.  Justice Kagan responded again with incredulity challenging Edison counsel “They don’t like changes.  They would rather have fees?”

Edison counsel also suggested that all that should be required of the prudent trustee is a periodic review to look only for changed circumstances.  He argued against the Supreme Court endorsing Tibble counsel’s position that the prudent trustee should also look and scour the market for cheaper investment options.  Interestingly, Justice Kennedy seemed to be endorsing the Tibble position when he responded that you certainly would scour the market for cheaper investment options if that’s what a prudent trustee would do.

The Justices focused much of their questioning first as to what kind of monitoring Tibble’s counsel was proposing, what kind of standard he was suggesting.  Then they looked to whether that was what a prudent trustee would do, and what kind of burden this would create for Edison in managing the plan, and finally what effect it would have on the plan participants.

The Justices appeared to support the Tibble plaintiffs’ new “prudent” investor standard.  This Supreme Court was also urged by the government attorneys from the Labor Department to accept this new standard as well.  If the high court adopts this new standard, which appears likely, it could have sweeping effects on companies and employees.  According to the Investment Company Institute, 401(k) plans held $4.4 trillion in retirement assets as of March, 2014.  Some of the funds offered to Edison employees had fees 37% higher than comparable institutional funds.

The Supreme Court’s decision is expected to be out sometime this summer.  It could change how companies fundamentally handle the way they invest for 401(k) plans.  They could move away from mutual funds to lower-cost methods such as collective trusts or separately managed accounts.  One option would be to appoint a “3(38)” fiduciary under ERISA, typically a registered investment advisor (RIA), to transfer the responsibility for managing the plans from themselves to the RIA.  Aside from potential changes in how such plans are managed, there is a lot at stake for both employers and employees in terms of potential litigation.  The Supreme Court’s decision could open a floodgate of litigation regarding the fiduciary duties of trustees for 401(k) plans sponsored by companies across the nation.  This is definitely one decision to keep on your radar.

References

Employee Retirement Income Security Act of 1974 (ERISA), Pub. L. No. 93-406, 88 Stat. 829 (codified as amended in scattered sections of 5 U.S.C., 18 U.S.C., 26 U.S.C., 29 U.S.C., and 42 U.S.C.).

Employee Retirement Income Security Act of 1974, 29 U.S.C. § 1113(1).

Tibble v. Edison International, 711 F. 3d. 1061 (9th Cir. 2013), cert. granted in part, 2014 U.S. LEXIS 4901 (U.S. Oct 2, 2014).