34.3 Law on Partnerships

Law on Partnerships

The Philippine Law on Partnerships is codified under Title IX, Book IV (Articles 1767 to 1867) of the Civil Code of the Philippines. A partnership is both a contractual relationship and a distinct legal person capable of owning assets, incurring liabilities, and suing or being sued in its own name. For CPALE candidates, mastering partnership law requires navigating the formal requirements of contract formation, the strict fiduciary obligations governing partners, the distinct rules of contract versus tort liabilities to third persons, the dissolution and winding-up mechanisms, and the special statutory governance of limited partnerships.

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1. Definition, Essential Requisites & Juridical Personality

Statutory Definition (Article 1767)

Under Article 1767 of the Civil Code, by the contract of partnership two or more persons bind themselves to contribute money, property, or industry to a common fund, with the intention of dividing the profits among themselves. Two or more persons may also form a partnership for the exercise of a profession (General Professional Partnership).

Five Essential Elements of a Valid Partnership

1. Valid Contract: Formed by mutual consent of two or more persons having legal capacity to enter into contract;
2. Mutual Contribution to a Common Fund: Each partner must contribute either money, property (tangible or intangible), or industry (labor, personal services, or professional skill);
3. Lawful Object or Purpose (Article 1770): Must be established for a lawful purpose. When an unlawful partnership is dissolved by judicial decree, the profits shall be confiscated in favor of the State, while partners retain their respective capital contributions;
4. Intention to Divide Profits (Animus Lucrandi): The primary purpose must be the realization of profits and their distribution among the partners;
5. Doctrine of Affectio Societatis: Mutual trust, confidence, and voluntary agency among partners.

Separate Juridical Personality (Article 1768)

Under Article 1768, the partnership has a juridical personality separate and distinct from that of each of the partners, even in case of failure to comply with the registration requirements of Article 1772. As an independent juridical entity:

• It can acquire and convey real and personal property in the partnership name;
• Partnership creditors have legal preference over partnership assets over the individual personal creditors of each partner;
• A partner's death, insolvency, or withdrawal dissolves the legal association.

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2. Formal Requirements & the Fatal Inventory Rule (Article 1773)

General Formal Rule (Article 1771)

As a general rule, a partnership may be constituted in any form (oral or written), except where immovable property or real rights are contributed thereto.

Capital of PHP 3,000 or More (Article 1772)

Under Article 1772, every contract of partnership having a capital of PHP 3,000 or more, in money or property, shall appear in a public instrument, which must be recorded in the Office of the Securities and Exchange Commission (SEC).

• Legal Effect of Non-Compliance: Failure to execute a public instrument or register with the SEC does NOT invalidate the contract of partnership. The partnership still acquires juridical personality and remains valid between the partners and liable to third persons as a de facto partnership.

The Fatal Inventory Rule for Immovable Property (Article 1773)

                         Article 1773: Contribution of Immovable Property
                                                 │
         ┌───────────────────────────────────────┴───────────────────────────────────────┐
         ▼                                                                               ▼
  MANDATORY FORMAL REQUIREMENTS                                                   CONSEQUENCE OF BREACH
1. Public Instrument (Notarized Deed)                                     If either the public instrument or the
2. Inventory of said immovable property                                    signed inventory is MISSING:
3. Inventory must be SIGNED by the parties                                 THE CONTRACT OF PARTNERSHIP IS
4. Attached to the Public Instrument                                              VOID AB INITIO!

CRITICAL CPALE RULE: Under Article 1773, a contract of partnership is VOID if real property is contributed, and an inventory of said property is not made, signed by the parties, and attached to the public instrument. This nullity is absolute and can be invoked even by the partners themselves, because the requirement is designed to protect third-party public registrants dealing with real property titles.

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3. Classification of Partnerships and Partners

Classification as to Object

1. Universal Partnership:
   • Universal Partnership of All Present Property (Article 1778): Partners contribute all property belonging to them at the time of formation to a common fund, including all profits acquired therewith. Future properties acquired by inheritance, legacy, or donation cannot be included, though fruits of such future properties may be.
   • Universal Partnership of Profits (Article 1780): Comprises all that the partners may acquire by their industry or work during the existence of the partnership. Properties owned by partners prior to formation remain their exclusive property; only the usufruct (use and fruits) passes to the partnership.
   • Presumption of Law (Article 1781): Articles of universal partnership, entered into without specification of its nature, only constitute a Universal Partnership of Profits.
   • Prohibition on Universal Partnerships (Article 1782): Persons who are prohibited from giving each other any donation or advantage (e.g., spouses under Article 87 of the Family Code) cannot enter into a universal partnership.
2. Particular Partnership (Article 1783): Has for its object determinate things, their use or fruits, or a specific undertaking, or the exercise of a profession or vocation.

Classification of Partners

• Capitalist Partner: Contributes money or tangible/intangible property to the common fund.
• Industrial Partner: Contributes purely his personal industry, labor, or professional expertise.
• General Partner: Liable for partnership debts up to the extent of his separate personal assets.
• Limited Partner: Liable for partnership debts only to the extent of his agreed capital contribution.
• Partner by Estoppel (Article 1825): A person who represents himself, or consents to another representing him to anyone, as a partner in an existing or non-existing partnership. Liable to third persons who extended credit relying on the representation.

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4. Obligations of Partners Among Themselves

Fiduciary Duty (Article 1807)

Every partner must account to the partnership for any benefit, and hold as trustee for it any profits derived by him without the consent of the other partners from any transaction connected with the formation, conduct, or liquidation of the partnership.

Statutory Restrictions on Outside Business Engagements

A highly tested topic in the CPALE is the stark statutory contrast between the outside business prohibitions imposed on industrial partners versus capitalist partners:

1. Exclude him from the partnership; OR
2. Avail themselves of the benefits obtained by him from the outside venture; PLUS damages in either case. | | Capitalist Partner | Article 1808 | RELATIVE BAN: Cannot engage for his own account in any operation which is of the SAME KIND OF BUSINESS in which the partnership is engaged (COMPETING business), unless permitted. | The capitalist partner must:
3. Bring all profits derived from the competing business into the partnership common fund; AND
4. Personally bear all losses incurred therein. |

Rules on Profit and Loss Sharing (Articles 1797-1799)

1. Distribution of Profits:
   • In accordance with the partnership agreement.
   • In the absence of agreement: Shared in proportion to capital contributions. The industrial partner receives a share that is just and equitable under the circumstances before capitalist partners divide the remainder.
2. Distribution of Losses:
   • In accordance with the loss-sharing stipulation.
   • In the absence of loss stipulation: Divided in accordance with the profit-sharing ratio.
   • In the absence of both: Divided in proportion to capital contributions.
   • Industrial Partner Loss Exemption (Article 1797): The industrial partner is strictly exempt from sharing in partnership operational losses among the partners.
3. Pactum Leonina Prohibited (Article 1799): Any stipulation which excludes one or more partners from any share in the profits or losses is void ab initio (except for the industrial partner's legal exemption from losses).

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5. Property Rights of a Partner & Tenancy in Partnership

Under Article 1810, the property rights of a partner are threefold:

1. Rights in Specific Partnership Property: Held under a special co-ownership known as tenancy in partnership. A partner has equal right to possess specific partnership property for partnership purposes. It is not assignable by an individual partner, nor subject to attachment or execution for individual debts (Article 1811).
2. Interest in the Partnership: A partner's share of the profits and surplus. Under Article 1812, a partner's interest in the partnership is personal property. It is assignable and subject to charging orders by judgment creditors of the individual partner (Articles 1813-1814).
   • Rights of an Assignee: An assignment of a partner's interest does not convey management rights or rights to inspect books. It merely entitles the assignee to receive the profits to which the assigning partner would otherwise be entitled.
3. Right to Participate in Management (Article 1803): When the manner of management has not been agreed upon, all partners are considered agents and have equal rights in management.

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6. Obligations and Liabilities to Third Persons

The Civil Code establishes a clear bifurcation between contractual liabilities and tort liabilities:

                                Partner Liability to Third Persons
                                                │
         ┌──────────────────────────────────────┴──────────────────────────────────────┐
         ▼                                                                            ▼
  Contractual Obligations (Article 1816)                               Torts / Delicts (Articles 1822-1824)
• Arising from partnership business contracts                         • Arising from wrongful acts, omissions, or
• All partners (including industrial partners)                           misapplication of money/property
• PRO RATA (Joint) and SUBSIDIARY                                     • All partners are SOLIDARILY LIABLE
• Separate assets answer after partnership assets are exhausted         with the partnership entity
• Stipulation exempting a partner is void as to 3rd persons           • Victim may sue any single partner for full amount

• Contractual Liabilities (Article 1816): All partners, including industrial partners, are liable pro rata (jointly) with all their property and subsidiarily for all partnership debts, after all partnership assets have been exhausted. Any stipulation exempting a partner from pro rata liability is void against third persons, but valid among the partners (Article 1817).
• Torts, Quasi-Delicts & Breach of Trust (Articles 1822-1824): Where, by any wrongful act or omission of any partner acting in the ordinary course of the business of the partnership, loss or injury is caused to any third person, the partnership and all partners are liable solidarily (jointly and severally).

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7. Dissolution, Winding Up, and Liquidation Order of Payment

The Three Stages of Partnership Termination

1. Dissolution (Article 1828): The change in the relation of the partners caused by any partner ceasing to be associated in the carrying on of the business. Dissolution does not terminate the partnership; it continues until winding up is complete.
2. Winding Up: The process of liquidating partnership assets, collecting receivables, paying debts, and distributing remaining surplus.
3. Termination: The ultimate point in time when all partnership affairs are completely wound up.

Causes of Dissolution (Articles 1830-1831)

• Without Violation of Agreement: Termination of term; express will of any partner at will; bona fide expulsion of a partner.
• In Contravention of Agreement: By the express will of any partner at any time. Under the doctrine of delectus personae, a partner always has the power to dissolve, even if he lacks the legal right (making him liable for damages for breach).
• By Operation of Law: Supervening illegality; death of any partner; insolvency of any partner or of the partnership; civil interdiction of any partner.
• By Judicial Decree: Insanity; permanent incapacity; conduct prejudicial to the business; persistent breach of contract.

Order of Payment of Liabilities in Liquidation (Article 1839)

When a general partnership is liquidated, assets are distributed strictly in the following statutory hierarchy:

$$\begin{aligned} \text{Rank 1:} & \quad \text{Those owing to creditors other than partners (Outside Creditors)} \\ \text{Rank 2:} & \quad \text{Those owing to partners other than for capital and profits (Inside Creditor Loans)} \\ \text{Rank 3:} & \quad \text{Those owing to partners in respect of capital} \\ \text{Rank 4:} & \quad \text{Those owing to partners in respect of profits} \end{aligned}$$

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8. Limited Partnerships (Articles 1843-1867)

A Limited Partnership is formed by two or more persons under the provisions of the Civil Code, having as members one or more general partners and one or more limited partners. The limited partners as such are not bound by the obligations of the partnership beyond their capital contribution.

Requisites of Formation (Article 1844)

• The partners must sign and swear to a Certificate of Limited Partnership setting forth statutory details (firm name, character, term, contributions).
• The certificate must be filed for record in the Office of the Securities and Exchange Commission (SEC).
• Effect of Non-Compliance: If there is no substantial compliance in good faith, the partnership is treated as a general partnership as to third parties.

Rules Governing Limited Partners

1. Contributions (Article 1845): A limited partner may contribute cash or other property, but never services or industry. A partner contributing services is an industrial partner and must be classified as a general partner.
2. Surname Rule (Article 1846): The surname of a limited partner shall not appear in the partnership firm name unless it is also the surname of a general partner or the business had been carried on under that name prior. A limited partner violating this rule becomes liable as a general partner to creditors who extended credit without actual knowledge that he is not a general partner.
3. Management Prohibition (Article 1848): A limited partner shall not become liable as a general partner unless he takes part in the control of the business. Active management strips the limited partner of limited liability.

Order of Payment in Liquidation of a Limited Partnership (Article 1863)

In settling accounts after dissolution of a limited partnership, the liabilities of the partnership are entitled to payment in the following order: