Court of Appeal Confirms that a Trust May Continue as a Partner in a Partnership Even After the Death of the Trustor

Invitation to partnership is often the culmination of years of hard work and dedication.  Therefore, partners are highly selective of those who are invited to join the ranks of partnership.  Careful consideration and forethought should be given when the partnership is contemplating the amendment of its partnership agreement.  The recent decision by the Court of Appeal in Han v. Hallberg demonstrates how perceived minor changes to the partnership agreement can have an everlasting impact upon the membership of the partnership.

In Han, the dispute involved the membership of a partnership formed by four dentists in 1975.  In addition to the ongoing dental practice, the partnership also owned and maintained the office building.  In 1994, the partnership agreement was amended such that Dr. Richard Hallberg, one of the partners, was permitted to transfer his interest in the partnership to his trust and substitute the trustee (then Dr. Hallberg) as a general partner.  The partnership agreement continued to have certain buyout procedures upon the death of a partner, including certain discounts that must be applied if the surviving partners invoke the buyout procedures.

In March 2010, Dr. Hallberg passed away.  The partnership agreement provided that if Dr. Hallberg were still a partner when he died, then his estate must give notice within ninety (90) days of Dr. Hallberg’s death that the estate intended to retain Dr. Hallberg’s interest for continued operation of the partnership.  If such notice is not given, then certain buyout procedures are automatically invoked.  Dr. Hallberg’s successor trustee failed to notify the partnership that the trust intended to retain Dr. Hallberg’s partnership interest within the ninety day period.  The surviving partners then gave formal notice that they intended to purchase Dr. Hallberg’s interest as set forth in the partnership agreement.  The successor trustee responded that the buyout procedures did not apply because the partnership interest was owned by Dr. Hallberg’s trust, not Dr. Hallberg individually.  Litigation ensued.

Ultimately the trial court sided with the surviving partners finding that under Presta v. Tepper, 179 Cal. App. 4th 909 (2009) Dr. Hallberg’s trust was not a distinct entity from Dr. Hallberg for the purpose of carrying on the partnership.  The trial court also found persuasive certain testimony from a surviving partner that the transfer of the interest to the trust was merely Dr. Hallberg’s method “to avoid probate and some taxes” rather than any substantive change to the relationship of the partners.  Accordingly, the trial court ordered that the trust’s interest in the partnership be sold at the reduced value required by the buyout procedures in the partnership agreement.  The trust appealed.

The Court of Appeal reversed the judgment in favor of the surviving partners and rejected the holding of Presta.  The Court of Appeal found “incontrovertible that Dr. Hallberg individually was not a partner when he died” based upon the express terms of the 1994 partnership amendment.  The Court of Appeal further reviewed the Uniform Partnership Act which expressly includes a “trust” and “business trust” within its definitions of “persons” that may associate to form a partnership.  The Court of Appeal also reviewed the provisions within the Uniform Partnership Act regarding the disassociation of a partner from a partnership which expressly states that the substitution of a successor trustee is not sufficient to result in disassociation of the trust as a partner.  Rather, the event leading to disassociation of a trust from a partnership is the “distribution of the trust’s entire transferable interest in the partnership.”  Such an event had not occurred.

In short, the Court of Appeal found the judgment in favor of the surviving partners as contrary to the express terms of the Uniform Partnership Act as well as the partnership amendment at issue.  While the Court of Appeal understood from the testimony at trial that the surviving partners may not have appreciated the effect of their agreement to the transfer of Dr. Hallberg’s partnership interest to his trust when they ratified the amendment in 1994, the Court declared “that cannot change the legal effect of their agreement.”  Thus, the Court of Appeal held that Dr. Hallberg’s trust continues to be partner in the dental group partnership, even though Dr. Hallberg passed away in 2010.

The Court of Appeal’s decision in Han v. Hallberg underscores the importance of partnership agreements to the continued existence and obligations between the partners.  Thorough deliberations should take place before any amendments to governing partnership documents are ratified.  Such deliberations should include the advice and counsel of an experienced corporate attorney.  Please contact the author, Shawn Ogle, or members of AALRR’s corporate team led by Cindy Strom Arellano with any questions you may have.  Mr. Ogle and Ms. Arellano can be reached at (562) 653-3200.

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