Small business, partnership law and software

Larry Ribstein —  25 September 2011

Two partners form a business in 1995 for providing dial up internet service to rural Wisconsin.  Their relationship deteriorates and in 1999 one (Bushard) withdraws, writing a letter expressly dissolving the partnership.  (The letter presciently noted that “this is an optimal time for selling the business at maximum value.” Indeed, a firm had expressed a willingness to pay $3.5 million for it.)  The other partner (Reisman) continued to operate the business for 11 years, taking a total of $700,000 in salary for his efforts.  In 2006 Bushard learned Reisman was taking a salary and filed a complaint for an accounting.

The Wisconsin Supreme Court, in Bushard v. Reisman, held that Reisman was entitled to no salary for all those years, despite the fact that he worked hard and did an excellent job maintaining the business while Bushard did almost nothing.  This being Wisconsin there was, of course, a strong dissent.

As the court explained, going to the Source (link added, footnote omitted):

An influential treatise explains that “[u]nless the partners agree otherwise, UPA § 18(f) [which has been codified in Wisconsin as Wis. Stat. § 178.15(6) ] permits compensation of partners for post-dissolution winding-up services, when dissolution is caused by death, but not in other cases.” Alan R. Bromberg & Larry E. Ribstein, Bromberg and Ribstein on Partnership § 7.08(d) (emphasis added.)

One is tempted to say, following Mr. Bumble, that if the law says that, “the law is an ass – an idiot.” Why shouldn’t a winding up partner get compensation?  And why distinguish winding up after partner death from winding up after partner withdrawal?

My treatise goes on to explain the distinction (footnotes omitted):

[O]n inter vivos winding up there is no reason to assume a change in the partners’ expectations concerning participation in the business and compensation, but on death of a partner the allocation of work shifts to the surviving partners to the exclusion of the deceased partner’s estate * * * which changes the partners’ expectations concerning work and compensation.

Surely, you would add, a partner who completely absents himself from the business comparable to one who is dead.  In fact, RUPA §401(h) changed the rule to provide for compensation in both situations.

Whatever the law says, you might insist, the court should have some power, as the plaintiff argued, to give equitable relief in such an egregious case.  But the court here returns to the Source:

“the partnership statute is, to a large extent, a standard form agreement that can be varied by the parties. Because the standard form often produces unwanted results, partners are well advised to give careful advance consideration to dissolution and its consequencesand to draft explicit agreements.” Bromberg & Ribstein, supra, § 7.01(c).

The court adds (footnotes omitted):

If the provisions of the UPA are unsatisfactory, partners can and should protect their interests by agreeing to different terms. In the absence of an agreement modifying the provisions of the UPA, a court should decline from fashioning an after-the-fact remedy in pursuit of an equitable result when that remedy contravenes the public policy choices established by the legislature.

There was another issue concerning whether the partnership continued or dissolved following dissolution (which determines, among other things, whether to value the partnership as of 1999 or a later date). The court held that the trial court could appropriately enter summary judgment based on the leaving partner’s lack of consent to continue the firm.

One wonders how this could be anything other than a continuation in which plaintiff acquiesced when it went on for more than a decade.  In fact, the court failed to consider an easier way to resolve the question:  the partnership must dissolve when there’s only one “partner” left.

So is the law an ass when it leads to the result of one partner running the business without objection by his absent co-partner for many years and then being denied any compensation for doing so?  When it allows a business to “wind up” for 11 years?

Well, consider that you gotta have clear rules.  This is what statutes provide, at least in this case.  If the parties don’t like the rules they can draft an agreement.  If they don’t know the rules they get what they deserve.

Still not satisfied?  I’m not either.  But the problem isn’t with the partnership law discussed above.  Where the law is really an ass is leaving the parties to a small business in a situation where they have to either know the intricacies of the law, driven by non-intuitive policy considerations, or hire an expensive lawyer who may deal with such transactions only rarely and may or may not understand what’s going on or what to do.

There is another way.  The parties could have access to inexpensive software that asks the parties a series of questions and then cranks out an agreement based on the law and the parties’ answers.  The parties might then show the agreement to a human lawyer to get a second opinion.  They would end up with a reasonably clear document that comports with current law that they could consult when events like partner withdrawal happen.

The problem, of course, is that this seemingly sensible approach is illegal.  The software would be engaged in the unauthorized practice of law. A lawyer could choose use such software to advise the client, but then the lawyer would have to forego the bigger fee he can get from customized advice.  The client can’t decide for herself whether to use lawyer, software or both.

Here’s where the law is really an ass.  The result is to frustrate and impede small businesspeople, part of the backbone of our commercial economy. These stories will multiply as people venture to try to rebuild our broken corporate economy by starting small sole proprietorships and partnerships.

Fixing these rules is something we can do to grow the economy without spending trillions of tax dollars.  Surely at some point the logic of this approach will become self-evident.

Larry Ribstein

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Professor of Law, University of Illinois College of Law

2 responses to Small business, partnership law and software

  1. 
    Lécia Vicente 5 October 2011 at 5:08 am

    Is “thinking small first” really attractive? Considering the fact that the uncorporation is still the legal form chosen by most small and medium business people, my answer is definitely yes. The flexibility naturally given to shareholders of uncorporations through default rules such as UPA§ 18(f) enables shareholders to protect their status quo in the company and to guarantee that the structure of the share capital, the ownership of the company and its control by shareholders is not altered. If, however, shareholders breach the company’s articles, rules (even default rules) should be duly enforced so that damaged shareholders are duly compensated.
    The following question arises: why do investors not keep on investing in the uncorporation, if they wish to play on the safe side and even benefit from the possibility to opt-out at any time from a regime they have agreed on? I would say it is because bargaining and enforcement does often involve high costs. The closed nature of the uncorporation and the costs of bargaining do not work as an incentive for locking-in capital and to attract “new blood”, particularly when the pay-offs of leaving the company “just like that” are much higher than the costs resulting from the enforcement of the default rule that the partner leaving or withdrawing the company has to bear.
    If “the law is an ass – an idiot.”, what is the role legislators and courts play or should play in order to solve this problem? I am considering this question from a European perspective. I suggest that legislators and national courts in Europe fully embrace a delegated task of revising and adjusting the parties’ own contractual relationships over time, either through the enactment of more attractive laws or judicial decisions.
    I am not comparing the US and Europe, in particular because I am not presenting the framework, nor the yardsticks of comparison of any jurisdiction in particular. Having had a look at the American case, however, I suggest a tentative concept of regulatory contractualization to be applied in European countries with civil law systems and code-based jurisdictions. This concept is developed on the basis of the horizontal effects of the market freedoms established in the EU Treaty, especially the freedom of capital movement foreseen in Article 63 of the Treaty on the Functioning of the European Union (TFEU or the Treaty). This Article guarantees the free movement of capital proscribing any unjustified restrictions thereof by Member States. For example, the judgments of the European Court of Justice (ECJ) on the so called Golden Share cases (i.e. those cases addressing golden shares assigned to states in the articles of association of privatized companies putting them in a position to block freedom of capital in the EU internal market) require national courts to look at contracts as well as to the contractual aspects of company law and read them according to the spirit of the freedoms of movement and observe the ECJ’s guidelines in their judgments.
    This should be especially the case if there are reasons to consider that parties have a right to claim the breach of freedoms of movement (which in principle are addressed to the Member States) against other private parties, or expect that the judiciary applies the constitutional principles of the Treaty when adjudicating the case between the parties. I suggest that this scheme of regulatory contractualization assign national courts the power to examine whether national provisions or measures are compatible with the market freedoms established in the Treaty, in particular the freedom of capital movement. By using defaults giving them the possibility to opt-out from a certain legal regime, shareholders will know that courts, whenever necessary, will undertake their delegated task of revising their own contractual relationship and adjust it. Will this solve the problem when the law is an ass and does not offer the parties better mechanisms of coordination and enforcement? Will this make European legislators and courts acting in a transnational context such as the European Union want to make law and legal institutions more attractive for the sake of deepening the integration of the internal market? These are not easy questions. I believe that the tasks of courts and legislators in Europe can be redefined in accordance with the constitutional principles of the Treaty so that also small entrepreneurs, who constitute the backbone of most European countries’ market economy, feel the incentive to invest in the uncorporation or at least not to disinvest. Still, the horizontal application of the Treaty’s provisions (i.e. the application of the Treaty provisions on freedoms of movement to private actors such as, for example, companies or firms), the framework of that application and its costs remain an open question.

    Lécia Vicente
    Florence, Italy

  2. 

    . . . hire an expensive lawyer who may deal with such transactions only rarely and may or may not understand what’s going on or what to do.

    1) is Ribstein admitting he is a failure at teaching? Surely his students would know what to do. If not, isn’t this problem his fault! Just days ago we had all those posts about law school taking to long.

    2) how would the consumer know the software is better than the lawyer? How could the consumer even find the software?

    3) what evidence is there that: (1) the lawyer is expensive (what would be a reasonable fee with $750k on the line; and (2) the lawyer does such rarely and (3) the lawyer may or may not understand

    4) who would bother to program for rare transactions. Technology funders look at projects that scale (ever read or heard Andy Kessler, Guy K, etc.?