The Oral Partnership Operating as a Corporation: Is it a Partnership? A Corporation? Can it be Both?
March 15, 2021
Oral agreements to form and operate business enterprises are a recurring subject of this blog. We’ve written many times, for example, about the comparative ease vis-a-vis other kinds of entities with which one can sufficiently allege an oral joint venture or partnership agreement.
We’ve also occasionally written about the phenomenon of curiously hybridized partnerships to form or operate a corporation, businesses in which the parties allegedly entered into a partnership agreement, but subsequently operated the business as a corporation (or limited liability company).
In a recent decision from Kings County Commercial Division Justice Leon Ruchelsman, Eikenberry v Lamson, 2021 NY Slip Op 30561(U) [Sup Ct, Kings County Feb. 19, 2021], the Court considered both of these concepts, authoring a scholarly opinion on New York’s legal rules for when an alleged oral partnership can survive the alleged partners’ subsequent decision to operate the business in a different entity form.
The Injunction Decision
Our regular readers may recognize Eikenberry. Just two months ago, we wrote about an injunction order in Eikenberry, using the opinion as a springboard to address the utility and importance of the injunction remedy in business divorce cases.
In the earlier Eikenberry decision, Justice Ruchelsman held that Eikenberry’s complaint and accompanying affidavit establish a “likelihood of success” on her claims that Eikenberry and her former longtime romantic partner, Lamson, formed an alleged oral partnership called “EL Partnership” to acquire, develop, and sell real estate through several real estate LLCs and corporations, several of which Eikenberry admitted were held solely in Lamson’s name, but which she alleged were all “beneficially owned” by EL Partnership.
In that prior round of litigation, Lamson submitted his own affidavit sharply disputing Eikenberry’s account of events, asserting that the lawsuit was a quasi-matrimonial case masquerading as a business divorce, categorically denying the existence of an alleged oral business partnership with his former paramour, and documenting that many of the real estate businesses supposedly constituting “partnership” property had long since operated in the form of LLCs or corporations.
The Dismissal Motion
Before we authored our last blog on Eikenberry, Lamson moved to dismiss Eikenberry’s complaint, consisting of seven causes of action predominantly dependent upon the alleged existence of an oral partnership at-will:
- Count One: Accounting of EL Partnership under Partnership Law § 44
- Count Two: Breach of Fiduciary Duty
- Count Three: Breach of Contract
- Count Four: Unjust Enrichment
- Count Five: Constructive Trust
- Count Six: Fraudulent Conveyance
- Count Seven: Judicial Dissolution of EL Partnership Under Partnership Law § 63
You can read the parties’ dismissal briefs here, here, and here.
The Rules of Law
In his opinion, Justice Ruchelsman authored a veritable treatise on the law governing oral partnership agreements. Some of the rules he relied upon (with some light editing, are as follows):
It is well settled that a partnership or joint venture need not be in writing to be enforceable (see Blank v Nadler, 143 AD2d 966 [2d Dept 1988]).
An oral agreement to form a partnership or joint venture for an indefinite period creates a partnership or joint venture at will (see Foster v Kovner, 44 AD3d 23 [1st Dept 2007]).
[T]he existence of an oral agreement is generally a question of fact which cannot be summarily determined on a motion to dismiss (see Martin v Cohen, 17 Misc 3d 1116 [A] [Sup Court, Suffolk County 2007]).
It is well settled in New York that a partnership or a joint venture may not operate through a corporate form and that any fiduciary obligations that the ‘partners’ owe one other cease to exist once they agree to conduct business as a corporation (see Weisman v Awnair Corp. of Am., 3 NY2d 444 ).
Lawyers being lawyers, it seems every rule has its exception. Justice Ruchelsman spent much of his decision addressing an exception to the fourth rule of law above (which the Court referred to as the “Weisman rule”):
In Miglietta v Kennecott Copper Corp. (25 AD2d 57 [1st Dept 1966]) . . . the court enunciated an exception to the Weisman rule where rights pursuant to the joint venture [may] survive the formation of any corporation ‘by virtue of a covenant or agreement which was intended to survive the merger of the joint venture into the corporate entity.’ . . . Indeed, in Blank v Blank (222 AD2d 851 [3rd Dept 1995]), the [Court] held a partnership can survive a subsequent corporate formation ‘as long as the rights of third parties, like creditors, are not involved and the parties’ rights under the partnership agreement are not in conflict with the corporation’s functioning.
Coalescing Principles of Law
Summarizing these contrasting legal principles, the Court devised the following standard:
Therefore, examining the precise situations where the joint venture or partnership survives the corporate formation, the following distinction emerges. Where the parties intend to reserve rights under the partnership or joint venture agreement, and such a reservation of rights does not interfere in any way with the management of the corporation or the rights of third parties, the joint venture agreement may be enforced. Intent may be gleaned from the actions taken. Consequently, where the individual partners actually abandon the partnership and embrace a corporate structure, then the partnership indeed dissolves.
The Court continued:
Thus, when the partners themselves actually form a corporation, or otherwise clearly intend to change the structure of the entity, the partnership necessarily dissolves into such corporation.
However, where the partnership exists and a corporation is created for some purpose, while the partnership remains intact, then, to be sure, the intent of the parties demonstrates the partnership need not dissolve.
Application of the Law to the Facts
Putting it all together and applying these rules, Justice Ruchelsman rejected the sufficiency of Eikenberry’s allegations that she and Lamson intended to own the corporations and LLCs under the “umbrella” of an oral general partnership.
The Court ruled that the complaint “does not allege any facts demonstrating the parties intended to maintain a partnership relationship following the incorporation of the entities,” and “does not allege any action taken by the partnership in any meaningful way permitting an allegation the venture survived the incorporation.” The Court concluded that it was Eikenberry’s burden to plead in her complaint the parties’ “intent to maintain the joint venture” post-incorporation, and “[n]o such intent can be gleaned from the complaint.”
The Court concluded:
[A]ll the facts indicate the joint venture dissolved. First, once the corporations were formed, there was nothing left for the partnership to do. Moreover, the plaintiff received shares and membership interests in the corporations evincing a dissolution of the prior joint venture. Essentially, the plaintiff is asserting that an all encompassing oral agreement was reached which by its very nature survived any further corporate formation to do precisely what the oral agreement proposed to do. Those claims are clearly barred by Weisman.
As a result, the Court dismissed the complaint as to “all allegations that are based upon any corporate activity,” allowing to survive dismissal only those portions of Eikenberry’s claims unrelated to property held in the name of a corporation or LLC.
Thoughts on Eikenberry
The lesson from Eikenberry is that it is possible under New York law to successfully allege the existence of a viable oral partnership whose partners subsequently operated the business, or held partnership property, in the name of a corporation or limited liability company.
But to do so, the plaintiff needs to allege in his or her complaint particularized facts that, if proven, would show the parties actually intended to maintain the general partnership or joint venture post-incorporation. It seems unlikely such an alleged oral agreement would survive dismissal based upon a rote, bare-bones incantation in one’s pleading of the alleged joint venturers’ “intent.” It will be a difficult task indeed to successfully plead such a claim where the only apparent purpose of the alleged oral partnership is to serve as a vehicle for the plaintiff to claim an ownership interest in real or personal property indisputably titled in the name of a corporation or LLC.
Rather, the pleader should be prepared to allege specific facts tending to show the parties’ intent, and to provide a plausible basis to believe the alleged oral partnership served some purpose that could not served by operating as a corporation or LLC. Notably, Eikenberry filed just days ago an amended complaint attempting to re-plead the existence of an oral partnership. It will be interesting to see if its new allegations will be sufficient.
A big thank you to Lamson’s counsel, Martin Krezalek, for sending me Justice Ruchelsman’s opinion.
Finally, to fellow Deadheads out there, see if you can find in Eikenberry some familiar song references sprinkled among the names of the various entities and properties. We are everywhere.