I have advised many regarding the dangers associated with a simple or general partnership. One of the problems is that they spring up spontaneously as the default business entity whenever two or more individuals or entities enter into a joint venture that involves the sharing of income and expenses. General partnerships in Iowa are governed by Iowa Code chapter 486A (Uniform Partnership Act). One of the major hazards is that each partner is an agent for the partnership and thus can bind or act on behalf of the partnership. There are exceptions to this rule. For instance, a lease is generally deemed not to create a partnership even though a crop-share agreement creates a very partnership-like sharing of income and expenses. However, courts have found in numerous instances that the facts of a particular case indicated that the tenant was the agent for the landlord. For instance, if the tenant routinely sells the landlord’s share of the crop at the local elevator and the landlord does not object, the local elevator can probably safely assume that the tenant has authority to sell the landlord’s share without any authorization from the landlord. It is for this reason that most leases, and especially crop share leases include a paragraph stating that the tenant is not an agent for the landlord. Another example is jointly owned real estate. Even though each square inch of property is owned together as parts of a jointly-held undivided whole, mere joint ownership does not give rise to the creation of a partnership. I believe the reason for this is that the courts find the idea that one joint owner could sell the property without the signature and consent of the other owners repugnant. However, as with the lease, the way in which the joint owners behave can change the default presumption and create an agency, whether memorialized in writing or not.
On the other end of the spectrum, the officers of a corporation are clearly agents of the owners (or shareholders) and the consent of the owners would not be required prior to an officer selling, mortgaging, or otherwise encumbering real estate or other assets of the corporation, unless the world is put on notice as to the specific restrictions on the powers of the officer or special requirements for certain types of transactions, such as sale, purchase or encumbrance of real estate.
The statutes laying down the ground rules and default provisions for various forms of business entity all presume some level of differentiation between management and ownership. For instance, the commentary to Iowa’s new limited partnership act states:
The new Act has been drafted for a world in which limited liability partnerships and limited liability companies can meet many of the needs formerly met by limited partnerships. This Act therefore targets two types of enterprises that seem largely beyond the scope of LLPs and LLCs: (i) sophisticated, manager-entrenched commercial deals whose participants commit for the long term, and (ii) estate planning arrangements (family limited partnerships). This Act accordingly assumes that, more often than not, people utilizing it will want: strong centralized management, strongly entrenched, and passive investors with little control over or right to exit the entity. The Act’s rules, and particularly its default rules, have been designed to reflect these assumptions.
My concern is that we may be moving in the wrong direction, even with a limited partnership. It would seem to me that strongly-entrenched, central management is what we have now and that it is the desire of the off-farm heirs that management as it relates to the landlord role be decentralized somewhat. I can understand if you find this advice frustrating. After all, when we began this process, I initially discussed a limited liability company [LLC] as a solution for the desire to limit liability that the off-farm heirs may face for problems that would be largely beyond their control and as a means to easily transfer fractional interests. However, when I saw the operating agreement that tenants’ attorney drew up, it was clear to me that an LLC posed the threat of further concentrating authority with the tenants, particularly if they were the only managers. Since then we have discussed limited liability partnerships [LLPs], limited partnerships [LPs], and general partnerships (mercifully, limited liability limited partnerships [LLLPs] were repealed in Iowa, effective Jan. 1, 2006).
At this point I am weighing three options: 1. Leave matters as they are with ownership of the land in joint ownership as tenants in common of undivided fractional interests. 2. General partnership. 3. Limited partnership with someone other than a tenant as the General partner.
1. Problems:
a. Requires ancillary probate in Iowa should an out-of-state owner pass away.
b. Still need a P.O.A. to sign up for USDA farm subsidies (could be someone other than Tenant) or all owners would have to sign any farm program paperwork as that became necessary (usually twice a year).
c. May have some sort of partnership already based upon the way the farm has been handled and without a written agreement, no one can be sure what the limits are.
1. Opportunities:
a. Each owner could have his or her separate lease with tenants; you could have a mix of cash rent and crop-share leases, depending on the owner’s preferences. (Such an approach might reduce the negotiating power of the owners, though not necessarily. You have a certain amount of leverage because you own a share of tenants’ homes.)
b. You might learn more details about the workings of the federal farm programs.
c. There is no doubt that each individual owner has the authority to have the property partitioned allowing the owner to obtain his or her fair market value of his or her share of the farm.
2. Problems:
a. No limitation on liability, which might be troublesome for off-farm owners who have no control over actions of on-farm owners. (Could require tenants to indemnify landlords as part of lease, which would cover most liability issues not already covered by property owners liability insurance.)
b. The right to partition, if any, will have to be spelled out in the agreement and will be limited to what the agreement says.
c. Minority owners may feel like they are being dictated to by the majority and there is some danger that the majority could take advantage of the minority. With such a small group it is difficult to avoid friction without requiring unanimity and that may not always be possible, particularly when moving to subsequent generations.
2. Opportunities
a. A written partnership agreement will spell out rights and limitations and can be amended as circumstances change.
3. Problems:
a. Management and liability for that management is concentrated in the general partner(s). (On the other hand, there is not that much management required on the landlord side of a crop-share lease agreement. It is primarily a question of auditing the tenant and evaluating whether the owners would be better off with a cash rent agreement.)
3. Opportunities
a. A written partnership agreement will spell out rights and limitations and can be amended as circumstances change.
b. The right to partition, if any, will have to be spelled out in the agreement and will be limited to what the agreement says. By statute, the right of limited partners to exit is severely restricted.c. Minority owners may feel like they are being dictated to by the majority and there is some danger that the majority could take advantage of the minority. With such a small group it is difficult to avoid friction without requiring unanimity and that may not always be possible, particularly when moving to subsequent generations.
