Welcome to Part 10 in our 12-part series entitled “12 Warning Signs You’re Headed for a Lawsuit with Your Partner”. If you missed Parts 1-9, click here to get to our Real Estate Investor bLAWg where you can find those and many other informative blog posts. The tenth warning sign is …
#10: Sloppy books and records
If your partnership keeps sloppy books and records (non-contemporaneous entries, lack of entries altogether, failure to properly characterize and document additional cash provided by one or both of the partners for the benefit of the partnership, commingling of funds, etc.), there is an excellent chance that when it comes time to settle up and pay out profits (or require more money in the form of cash calls), there will be a vigorous dispute over who is entitled to what.
Example: We had a developer client who was in a joint venture with another developer for a number of years and several development projects. Over that period of time, the joint venture needed money beyond the partners’ initial capital contribution. Our client had enough money to address the joint venture’s need; his partner did not. Our client provided substantial additional funds to the joint venture over many years, but failed to characterize his additional contributions as additional capital contribution. A dispute arose as to whether our client’s additional funds should be treated as additional capital contributions or a loan to the joint venture. Treating them as additional capital contributions would mean our client would be entitled to a greater percent of the profits; if treated as a loan, the partners’ profit shares would not change. The difference between those two methods of characterizing our client’s additional funds amounted to a seven-figure dispute. This dispute ended up going to trial and, while our client was happy with the outcome, the expense of going to trial, not to mention the time and aggravation, was significant and could have been avoided had the client had a better operating agreement (the defective operating agreement our client used was drafted by another lawyer, not by us; our operating agreement always addresses and documents how additional partner funding is handled and characterized and, therefore, would have avoided any dispute on this point) and/or had kept more accurate books and records.
Solution: Do whatever it takes to nip this problem in the bud now. Clean up your books and records immediately.