When entering into a business relationship, there are many factors to consider. Additionally, many people don’t even realize that they have legally entered into a business partnership at all. Once you do, however, you may be held legally and financially liable for the actions of your business partner or partners.
Bartenwerfer v. Buckley
Enter, Kate M. Bartenwerfer, of San Francisco. Many years ago, she jointly owned a San Francisco home with her soon-to-be husband, David Bartenwerfer. They both decided that David would renovate the home, which he did. They sold the home to Kieran Buckley, who found there to be undisclosed defects to the home, and decided to sue the Bartenwerfers. Buckley was awarded $200,000 and the Bartenwerfers were unable to pay this. Due to this and other debts they owed, Bartenwerfers filed for bankruptcy, but were not allowed to discharge the $200,000 debt because it was incurred as a result of fraud.
Because Kate had been nothing more than a passive investor, she sought separately to free herself from this debt, and was denied. The courts found again and again that although she did not know about the deception, her status as a partner in the financial dealings concerning this San Francisco residence meant she was also financially liable. This case has taken years to resolve, and finally made its way up to the Supreme Court. In February, 2023 the supreme court ruled for Kieran Buckley, stating that no debt being incurred by fraud of any kind should be discharged, even if the individual did not commit the fraud directly.
The financial outcome of this decision is bleak for Kate Bartenwerfer. Unless she is making a great deal of money, she will likely be paying for David’s misconduct for the rest of her life.
What Business Planning Steps Prevent This Outcome
While this may seem like a harsh judgment, these laws and statutes are there to protect individuals from potential, purposeful fraud. If this was not the case, a partnership could allow one person to directly commit the fraudulent actions, while many others benefit from these actions and are never held responsible due to their ignorance of the details.
As business planning attorneys, we cannot give legal advice on this blog. We can recommend that before setting up any arrangements with anyone, including family members, that can be interpreted as business arrangements, you meet with a qualified attorney and ensure that there are legal protections put in place for individuals and entities. We cannot always know what another person will or will not do, even if we feel we know them well.
One of those legal protections would be the creation of an LLC, or limited liability corporation. This legal entity can protect an innocent individual from being held personally liable for the misconduct of another member of the corporation. One who is committing fraud will still be held personally liable, regardless of the legal protections in place. An additional step available is a specific type of trust, called an asset protection trust. While it is common sense not to enter into business dealings with people you don’t trust, sometimes the people we do trust can surprise us. It is always better to cover your legal bases.
Conclusion: Proper Business Planning is the Key
While we feel for Kate and others like her, we hope that you will learn from her story. Even if an individual does not directly participate in any fraudulent activity, if they are in a partnership with someone who does, they are liable. A legal partnership can be formed when two or more people are acting together towards a common, financial goal. Before entering into any financial arrangements, meet with a trusted legal advisor, and make sure you, and your assets, will be protected.
To listen to our full podcast about Kate, click here.