Question

Toady and Froggy were running a vegan cafe together. The business was having financial difficulties.Betelguese, who has known Toady and Froggy for many years had recently inherited a lot of money and Toady and Froggy asked him to lend the business $100 000 to enable them to buy sufficient stock and to upgrade the cafe for the summer season. Betelguese wanted to help his friends but also wanted to ensure that he would get his money back. He agreed to lend Toady and Froggy the money in return for a payment of $10 000 per year out of the gross returns of the cafe. The terms of the loan also provided that Toady and Froggy would consult Betelgeuse about any major contracts entered into by the business and gave him a right to inspect the accounts at regular interval.

Required:

a. Discuss whether or not a partnership exists between Toady, Froggy and Betelgeuse?

b. Would it make any difference if the terms of the loan provided for Betelgeuse to be paid $10 000 per year out of the profits of the business?

Answer 1

a. Yes, a partnership does exist between Toady, Froggy and Betelgeuse.

Even before Betelgeuse came into the picture, Toady and Froggy were running the business as a partnership.

The factors that are considered while deciding whether a partnership exists or not:

1. Formal registration of the partnership.

2. Contribution of money or other assets to the business.

3. A mutual right of control or management of the business.

4. Right to participate in the profits of the business.

Even where a partnership has been formally registered, the court might decide that a partnership does not actually exist if conditions (3) and/or (4) are not present.

In the given situation, Betelgeuse expects a return of $ 10,000 out of the gross returns of the business, which can be viewed as interest on capital contributed by him to the firm. Also, the terms were that Betelgeuse would be consulted on major contracts entered into by the business and gave him a right to inspect the accounts at regular interval.

Since conditions 2,3 & 4 exist in the arrangement between them, it appears to be nothing but a partnership.

b. No, it would not make any difference. If the terms of the loan provide for Betelgeuse to be paid $ 10,000 out of the profits of the business, it indicates that Froggy and Toady have allowed him to participate in the profits of the business. Therefore, it is still a partnership between them.