August 27, 2013
Absent an Agreement to the Contrary, the California Uniform Partnership Act Controls the Scope of a Departing Partner’s Liability to a Former Partnership for Partnership Obligations Incurred by the Firm after Partner Dissociation
A significant issue for departing partners is to understand and evaluate the scope of any potential liability he or she may have to their former partnership once the departing partner provides notice of departure and dissociates with that partnership. In some instances, partnership agreements set forth specific terms upon which a departing partner may continue to have obligations to its former partnership for certain firm management expenses that the former partners had agreed to share for a reasonable period of time beyond the terms of the partnership.
However, unless the partnership agreement contains a specific defense and indemnity or liability provision, the departing partner is not liable for any partnership obligations incurred by the firm after the departing partner dissociates from the firm or after his or her interest in the partnership is terminated. In fact, unless there is an agreement to the contrary, it is the partnership that must indemnify a former partner from all partnership liability incurred before or after the dissociation, with only minor exceptions.
Under the California Uniform Partnership Act (“UPA”), Cal. Corp. Code Section 16701(d), “A partnership shall indemnify a dissociated partner whose interest is being purchased against all partnership liabilities, whether incurred before or after the dissociation, except liabilities incurred by an act of the dissociated partner under Section 16702.” Cal. Corp. Code Section 16702 sets forth some minor exceptions to this rule that relate to the notice and knowledge by third parties of the dissociation for acts incurred after the departing partner’s dissociation.
In addition, pursuant to Cal. Corp. Code Section 16703(a), although “a partner’s dissociation does not of itself discharge the partner’s liability for partnership obligation incurred before dissociation,” a dissociated partner “is not liable for a partnership obligation incurred after dissociation” except in certain circumstances similar to Cal. Corp. Code Section 16702.
It is important, however, to understand the applicability of these provisions in the context of a Limited Liability Partnership – which is the legal entity under which most law firm partnerships are formed and conduct business. The UPA Section 16306(c), states that “[n]otwithstanding any other section of this chapter, … a partner in a registered limited liability partnership is not liable or accountable, directly or indirectly, … for debts, obligations, or liabilities of or chargeable to the partnership or another partner in the partnership….” Section 16306, subdivision (d), goes on to state that “all or certain specified partners of a registered limited liability partnership, if the specified partners agree, may be liable in their capacity as partners for all or specified debts, obligations, or liabilities of the registered limited liability partnership if the partners possessing a majority of the interests of the partners in the current profits of the partnership, or a different vote as may be required in the partnership agreement, specifically agreed to the specified debts, obligations, or liabilities in writing, prior to the debt, obligation, or liability being incurred.” Rappaport v. Gelfand (2011) 197 Cal. App. 4th 1213, 1230-31.
Thus, when a partner is considering departing from his or her existing firm, it is important that the partner has a clear understanding of his or her obligations to the partnership for partnership liabilities, obligations and/or debt. In the limited liability partnership context, only those limited partners who previously agreed to the imposition of a specific debt, obligation or liability can be held personally liable to the partnership for that partnership obligation. Rappaport at 1231 (emphasis added.) General provisions in a partnership agreement that state that a departing partner is liable for “ongoing partnership liabilities” for a certain period of time after the partner disassociates from the firm, without more, are likely too vague to enforce against the departing partner.
However, prior to making a lateral move, a departing partner should closely analyze what items he or she has agreed to assume in terms of liability to the former partnership. Ideally, these potential liabilities, among other departure related issues, are resolved between the departing partner and the former partnership as part of a separation agreement between the parties following the disassociation.