Partnership’s Incorporation Insulates Partners From Personal Contractual Liability

Today’s post features the case law equivalent of a Deep Cut.  The Deep Cut – as musical buzz-phrase and phenomenon – appears to be gaining traction in the FM radio realm.

The moniker denotes an obscure song from a well-known artist that’s not normally associated with the artist.

For example, a Styx fan likely connects that band with radio staples “Babe” or “Renegade”; instead of their lesser-known cuts “Queen of Spades” or “Castle Walls.”

“Hair metal” fans might associate Guns N’ Roses with its FM stalwarts like “Welcome to the Jungle” or “Sweet Child O’ Mine” instead of its more remote offerings, “One in a Million” or “Coma.”

Jensen Sound Laboratories v. Long, 113 Ill.App.3d 331 (4th Dist. 1983)  is “deep” in the sense that it’s both dated (1983) and geographically remote (4th District).  But the case is still post-worthy because its salient issue  – corporate vs. personal contractual liability – continues to recur in my practice.

The plaintiff creditor sued the defendants – a husband and wife who were also officers of a defunct corporation – for breach of contract after the corporation dissolved.  The defendants had previously operated a partnership before incorporating under a similar sounding name.

The plaintiff had done business with the partnership under an open-end credit agreement where the plaintiff would provide services to the partnership and then submit invoices to it.  After the defendants dissolved the partnership and began operating as a corporation, they continued ordering services from the plaintiff and would pay with checks bearing the corporate name.

Defendants never formally notified plaintiff of the incorporation and plaintiff never asked why a corporate entity was paying plaintiff’s invoices.

When the corporation dissolved, plaintiff sued the individual defendants for past-due invoices.  After a bench trial, the court ruled in favor of the defendants and found that plaintiff’s remedy was against the defunct corporation; not the individual defendants.

Held: Affirmed.

Why?

Normally, a partnership must give creditors notice of the partnership’s dissolution in order to relieve the partners of personal liability for debts incurred in the partnership’s name.

But where a partnership morphs into a corporation, the (former) partnership is no longer liable for partnership debts unless the partnership continues to deal with third parties in the same manner as before and fails to give notice of the partnership’s dissolution or change in form.

The critical fact relied on by the court was that the plaintiff received corporate checks for almost two years before it sued the individual defendants.

Since there was no evidence that the defendants continued to deal with the plaintiff as a partnership once the defendants incorporated, the trial court correctly found that the plaintiff was (or should have been) on notice of the change in business form.

Take-aways:

1/ where a business entity changes forms (e.g. partnership to a corporation), the members of that entity should notify creditors to possible personal liability to those creditors.

2/ Where someone fails to notify creditors of a change in business form, he can still avoid personal liability if the parties’ course of conduct demonstrates that the creditor was objectively put on notice of the structural change.

3/  A lengthy time span of receiving payment via corporate checks without objection can be viewed as constructive notice of a business entity change.

 

 

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PaulP

Litigation attorney at Fisher Kanaris, P.C. representing businesses and individuals in all types of commercial disputes.