What Happens When a Partner in a Partnership Commits Fraud?

When you go into business as a partnership, you might not want it to happen, but you are aware of the risk, that a partner doesn’t pull his or her weight, or that the partner doesn’t fulfill his or her obligations under a partnership agreement.

What you may not anticipate–and what you may not even be aware is even happening as it happens–is a partner defrauding someone outside the partnership, whether it’s a member of the general public, or another business your partnership is working with.

Personal Liability for Fraud

Normally, if a partner makes an error, there is concern for the business itself. The business can be sued, or else assets or suffer whatever other consequences that stem from the error.

But fraud presents a different problem, because there is no corporate veil for fraud; that is, when your business defrauds someone, that defrauded person can seek damages not just against the company or partnership, but against the individual owners or partners, personally. There simply is no company protection from lawsuits, when it comes to fraud.

And that can be very frightening–if a partner commits fraud without the other knowing, the “innocent partner” may now fear a loss of his or her own, personal assets, even though that partner had no idea that the fraud was even happening.

Are You Liable if You Didn’t Know?

The good news is that as a general rule, one partner cannot be held liable for the fraud committed by the other partner. However, the law will use a “should have known” standard to see if the innocent partner truly had no idea whether or not the fraud was going on.

In other words, even if you didn’t actually know that the fraud was happening, if you could have discovered it or should have, and failed to do so, you, as the innocent partner, could be liable for your partner’s fraudulent activities.

As an example, if your partnership is getting a lot of complaints from customers about being misrepresented or deceived, or if the business suddenly starts bringing in loads of money with no logical business explanation for the generation of that money, and you chose to just ignore these telltale signs that something may be amiss, you cannot remain purposefully ignorant; you could be held liable for your partner’s fraudulent activities.

The size of your partnership may matter as well, and most partnerships are smaller; they don’t have middle management and directors and numerous officers, the way traditional companies do.

The smaller the company the more involved each partner presumably is in the day to day activities of the partnership and thus, the more likely it is that an innocent partner could have discovered or should have known of the other partner’s fraudulent behavior.

No Discharging a Fraud Judgment

Another scary thing about a partner committing fraud is that bankruptcy is not an option, if you are sued and owe money because of fraud.

Fraud cannot be discharged in bankruptcy. That means that if a fraud judgment is entered against you because a court or jury feels that you knew of your partner’s fraud, and did nothing about it or participated in it, you won’t be able to go to bankruptcy court to try to have the judgment discharged.

Questions about your partnership?  Call our Fort Lauderdale business attorneys at Sweeney Law P.A. at 954-440-3993 for help.

Sources:

vlaa.org/piercing-the-corporate-veil-a-legal-mechanism-for-accountability/

library.nclc.org/article/new-supreme-court-ruling-when-bankruptcy-debtor-hook-partners-fraud