The Rogue Partner and the Undisclosed Side Deal
A, B, and C formed a general partnership to run a restaurant. The partnership agreement named A managing partner and required B and C's approval for any expenditure over $25,000. Without approval, A signed a $60,000 contract with Vendor for a new kitchen system. Vendor's salesperson had been told by B at a trade show that A could not bind the partnership above $25,000. Vendor delivered and the restaurant used the equipment. A also borrowed $40,000 in the partnership's name from Bank, telling Bank he was authorized. A used $15,000 of the loan for personal expenses. Bank had no notice of the $25,000 limit and made no inquiry. C learned of both transactions and seeks to rescind the Vendor contract and avoid the Bank loan. Vendor sues for the contract price; Bank sues for repayment. The partnership has $80,000 in assets and $90,000 in liabilities. Assume the jurisdiction has adopted the RUPA.
1. Is the partnership liable to Vendor? Can C rescind?
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A's actual authority was limited by the partnership agreement: he could not bind the partnership to expenditures over $25,000 without B and C. Vendor knew of that limit because B told Vendor's salesperson. Actual authority is therefore absent, and apparent authority is also absent: a third party who has actual notice of the limit cannot reasonably rely on the partner's contrary representation. The partnership is not liable to Vendor on an authority theory. However, the partnership accepted and used the equipment after C learned of the contract. Under RUPA, a partnership may ratify an unauthorized act. Ratification can be implied by retaining benefits with knowledge. Rescission would require returning the equipment; because the restaurant used it, rescission is unavailable. C can recover any excess over fair value from A, but the partnership likely must pay the contract price or restitution. The best answer: no liability initially, but ratification by acceptance and use makes the partnership liable, and C cannot rescind.
2. Is the partnership liable to Bank?
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Bank can enforce the loan against the partnership. A was the managing partner. Borrowing $40,000 in the partnership's name was within the ordinary course of the restaurant's business. Bank had no notice of the $25,000 limit and made no inquiry. Under RUPA, a partner's act apparently carrying on the ordinary course binds the partnership unless the third party knows the partner lacks authority. A's statement of authority and Bank's lack of notice support apparent authority. The fact that A used $15,000 for personal expenses does not defeat Bank's claim if Bank did not know; the partnership bears the risk of the rogue partner and can sue A. C cannot avoid the loan. The partnership must repay $40,000, and A is liable to the partnership for the $15,000 misappropriation and any resulting damages.
3. What claims does the partnership have against A?
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The partnership has claims against A for breach of the fiduciary duty of loyalty and for indemnification. A exceeded the $25,000 approval limit, self-dealt with $15,000 of partnership funds, and exposed the partnership to liability. Under RUPA, the partnership can recover the $15,000, any loss from the Vendor contract, and possibly disgorgement of any personal benefit. C can also seek A's dissociation or dissolution if A's conduct makes it impracticable to carry on. The partnership's $80,000 in assets and $90,000 in liabilities mean it is insolvent by $10,000; A's indemnity claim may be subordinate to creditors. C's personal liability as a partner is joint and several for partnership debts, but C has a contribution right against A.