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Attorneys’ Fees in a Partnership Buyout

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Corporation Code section 16701 allows an award of attorneys’ fees against a party who acted arbitrarily, vexatiously, or not in good faith but that award is discretionary.

Los Angeles partnerships (and throughout California) are governed by the California Revised Uniform Partnership Act (UPA), which was adopted in 1996 and applies to all partnerships as of 1999.  The statutory scheme regarding partnerships provides that the association of two or more persons to carry on as co-owners a business for profit forms a partnership, whether or not the persons intend to form a partnership.

Note for real estate attorneys:  Partnerships are not just those relationships that are formally set forth in a written partnership agreement with proper partnership bank accounts and accounting.  In fact a partnership agreement can be written, oral, or implied.  It will be up to the person alleging the partnership to prove its existence.

The terms of a partnership are controlled by the partnership agreement.  However, if the agreement does not cover a particular issue, the UPA will govern. Relations among the partners and between the partners and the partnership are similarly governed by the partnership agreement, or if not address, by the UPA.

Dissociation of a Partner in a Partnership

Corporations Code section 16601(a) provides for the dissociation of a partner upon the partnership’s having notice of the partner’s express will to withdraw as a partner or on a later date specified by the partner.  The UPA provides that the partnership must buy out the dissociated partner’s interest in the partnership and subsection (b) sets forth a process for valuing the partner’s interest.

After Partnership Dissociation—Attorneys’ Fees Award?

Subdvision (i) allows a court to assess reasonable attorneys’ fees and the fees and expenses of appraisers or other experts, in an amount the court finds equitable, against a party that the court finds acted arbitrarily, vexatiously, or not in good faith.  The statute provides an example of the type of conduct that may justify a fee award:  “the partnership’s failure to tender payment or an offer to pay or to comply with its disclosure obligations for any buyout.

Recently the California Court of Appeals dealt with this issue in a case entitled Jones v. Goodman (2020) 57 Cal.App.5th 521.  In this case two entrepreneurs who were successful in defending against a colleague’s suit seeking an alleged partnership buyout filed a motion to recover their attorneys’ fees.  The trial court denied the motion.

The American Rule:  Pay Your Own Attorneys’ Fees

The appellate court noted some basic governing legal principles.  First, California follows what is commonly referred to as the American rule, which provides that each party to a lawsuit must ordinarily pay his own attorney fees.  There are exceptions to this general rule set forth in various statutes and the parties can always contractually agree to the recover of attorneys’ fees.

Corporations Code section 16701 Exception

Corporations Code section 16701(i) is another exception.

The court noted that it would follow well established principles of statutory interpretation so as to give the statute a reasonable construction conforming to the Legislature’s intent.  Moreover, an appellate court will generally review a trial court’s award of fees and costs for abuse of discretion, reasoning that in fashioning an equitable remedy, the trial court is in the best position to determine whether the criteria for a fee award have been met.

The court noted that there is no case law defining “arbitrarily, vexatiously, or not in good faith” under this fee shifting statute.  It then engages in some legalistic analysis to conclude that (1) the terms are disjunctive and each may provide a basis for a fee award; (2) attorney fees may be warranted based on claims that objectively lack legal merit or are subjectively pursued in bad faith (or both); and (3) the decision to award attorney fees is not mandatory but rather lies within the broad discretion of the trial court.

The court looked at various legal precedent to ascertain the meaning of the terms and at similar cost shifting provisions in other statutes.  For example, in a trade secret misappropriation claim a court concluded that ‘bad faith’ requires “objective speciousness” as opposed to “frivolousness”.  In a probate action “reasonable cause if evaluated under an objective standard of whether any reasonable person would have tenably filed and maintained the objection” and “bad faith involves a subjective determination of the contesting party’s state of mind—specifically, whether he or she acted with an improper purpose.”  Lastly, in a Business & Professions Code case the court held that ‘frivolous’, ‘unreasonable’, and ‘without foundation’ are objective standards while ‘bad faith” is a subjective standard concerned with a defendant’s motives for defending or litigating a lawsuit.

The Jones court concluded that the fee shifting provision of Corporations Code section 16701(i) contained both objective and subjective criteria.  But the court reaffirmed that making this determination is left to the trial court’s discretion.  In fact the court noted that “the Legislature knows how to adopt mandatory fee shifting statutes when it desires” and set forth some examples.  This statute, however, did not impose a mandatory obligation on the trial court.

Were Plaintiff’s Partnership Claims Arbitrary, Vexatious or Not In Good Faith?

The court therefore looked at the specifics of the Jones case.  Jones’ claim survived summary judgment and proceeded to trial.  There was no dispute at trial that the parties had discussed some type of business arrangement.  There had even been a proposed written agreement that used the term ‘partners’ and described the objectives and expected contributions from the parties.  The gist of the case was that the parties “simply disputed the nature and existence of their business relationship.”

The court noted that partnership law in California holds that “the ultimate test of the existence of a partnership is the intention of the parties to carry on a definite business as co-owners.  Such intentions may be determined from the terms of the parties’ agreement or from the surrounding circumstances.”  The trial court heard evidence on the circumstances, intentions and beliefs of all the alleged partners.  It ultimately held that no partnership was formed but the question is whether no reasonable attorney would have advanced such arguments.  This is the objective standard and the appellate court found that it could not say that no reasonable attorney would have advanced such arguments.

The appellate court then looked at Jones’ subjective good faith in bringing the lawsuit.  The trial court believed that Jones pursued the action in subjective good faith, based on his honest but mistaken belief that the men had agreed to form a partnership.  The appellate court pointed out that the trial court was in the best position—after having observed all of the parties at trial—to determine whether Jones acted with a subjective good faith.  The trial court ruled that plaintiff did not act arbitrarily, vexatiously or not in good faith.

The Trial Court Has Discretion to Award Fees In Partnership Dissociation Cases

The moving parties had argued that plaintiff’s action were arbitrary ‘as a matter of law’ based on the trial court’s finding in the judgment.  Both the trial court and the appellate court rejected this view.  The appellate court stated that the trial court could exercise its discretion to conclude that—based on the its consideration of the totality of circumstances and the objective and subjective statutory criteria in section 16701—a fee award was not justified in this case.

Lessons for partnership litigation lawyers in Los Angeles 

A big part of most litigation is the cost-benefit analysis—how much will it cost to “win” versus the ability to settle.  Defendants in the Jones case were seeking $349,000 in attorney and expert fees.  Even though they “won” the case, they are still out a huge amount of money for what looked to be a small company.  With a mandatory fee-shifting provision, defendants could have at least taken solace in the fact that they would be given a judgment for attorneys’ fees.  However, with a discretionary provision, attorneys’ fees are never certain.  In fact I would hazard a guess that using a standard of “arbitrary, vexatious or not in good faith”, most trial court’s would lean toward denying the recovery fees in most cases.  Business attorneys and their clients need to take this into account when evaluating the best strategy for dealing with a case like this.

Los Angeles partnership litigation lawyer Laine Wagenseller is the founder of Wagenseller Law Firm and handles partnership lawsuits (including partners, shareholders and LLC members).  For more information on our practice, please visit www.wagensellerlaw.com or call us at (213) 286-0371 for more information.

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