Can my business partner do that?!

Can my business partner do that?!

April 13, 2018

Frank came into the office one morning, much like any other morning. Frank, along with his business partner Tom, had started their own business about a year ago, and the company was just starting to turn the corner towards profitability. Frank was hopeful that they could issue their first distribution of the profits in the coming weeks, and he had already gone shopping with his wife to pick out the car on which they wanted to put that money as a down payment.

When Frank walked in, however, their small office space was filled with unopened boxes, so much so that Frank had to jump over a couple to get to Tom's office. When he walked in, Tom was bleary-eyed behind his desk, self-medicating with a little hair of the dog from the night before.

"What the hell is all this, Tom?!" Frank shouted, startling Tom from his stupor. 

Tom, nursing a coffee mug that only just might have had coffee in it, looked excitedly at Frank, "You remember those new workstations we were so excited about a couple of months ago? I went ahead and got them for the new office! I wanted it to be a surprise for you and have them all set up this morning, but Jake from SysCorp and I made a late night of it. It's been a rough morning."

Frank was speechless. Without saying another word, Frank went back to his office and pulled up the company credit card from last night. His jaw dropped as he saw that Tom and Jake, the rep for their company's biggest client, SysCorp, had blown more than $1,500 in one night hitting what seemed to be every restaurant, bar, and nightclub in town.

Furious, Frank calls his attorney. Fed up with Tom, Frank recounts the story and asks, "Can he do that?!"

The Default

Chances are, your partner can do all that, and probably more. By default, a partner in a partnership, a member in a limited liability company, and an officer of a corporation all have the authority to authorize and incur any expense reasonably calculated to benefit the company or its mission. In Frank's case, this would probably include new furniture for the office or entertaining a high-value client.

Further, because Frank is the owner of the company, he gets paid last. This means that those expenses will have to be covered by the company before he gets his distribution.

Unfortunately for Frank, that new car is going to have to wait.

How to Fix It

The defaults are only the defaults for as long as they aren't corrected in an agreement. For instance, if Frank and Tom had discussed the furniture issue previously, but they had both agreed to hold off on purchasing the furniture until a later date, Frank would have a good argument to state that that purchase is Tom's responsibility alone.

This is the reason that Partnership Agreements, Operating Agreements (for LLCs), and Articles and Bylaws (for corporations) are so important. These are agreements that the owners put in place setting expectations between themselves and how they'll run the company. Not only do these agreements often outline the expectation on how purchases like these will be handled, but if something is bought inappropriately, these agreements also handle how to remedy the situation, potentially saving thousands of dollars in litigation costs trying to sort out what could have easily been prevented.

Where Most Business Owners Screw Up

Unfortunately, most business owners don't take this step seriously. They might spend inordinate amounts of time quashing bugs in their code, or trying to prevent competitors from stealing their ideas, but they rarely realize that one of the most common liabilities is often the guy or gal in the office next door.

While hard statistics are hard to come by, it's estimated that as many as 50% of business partnerships will fail in the first 2-3 years. I have seen this estimate play out in my practice. (Meanwhile, I have only seen one or two legitimate cases of a competitor stealing a concept.) In many of these situations, the owners of the company were so excited about getting started and so sure of their own success that spending the time, money, and effort on something as seemingly-useless as a "business pre-nup" was not only financially wasteful, but karmic suicide.

Bottom Line

Get a partnership agreement, in writing. As lawyers, we call them Partnership Agreements, Founders Agreements, Shareholder Agreements, Operating Agreements, Company Agreements, Articles, and Bylaws. They are all effectively the same thing: What are we doing as owners, and are we on the same page? 

Don't just pull one off the internet or think that a form agreement will do the job either. As I've mentioned before: Online forms are like lamppost bubble gum: They've been used before and left behind for a reason. If you're as serious about this business as you think you are, be as serious about your business partnership as you are about your spousal partnerships. You're effectively "marrying" your business partner, but there are far more laws to protect a divorcing spouse than there are to protect a separating business partner.