Is One Partner Liable for the Fraudulent Activities of the Other Partner?

One of the great things about forming a partnership or other type of legal entity, is the corporate veil. You, personally, are shielded from the lawsuits and liabilities of the business or partnership, as the business is its own separate legal entity. Someone suing may be able to reach the business’ assets, and put it out of business, but it cannot touch your personal assets.

The Fraud Exception

One of the few exceptions to the rule is fraud. A partner or owner of a business who commits fraud, can be held personally liable to the suing Plaintiff, and cannot hide behind the corporate veil.

But partnerships create a special problem, because often, one partner may be doing something behind the back of the other partner, and without the other partner’s knowledge. If that something is fraud, the question then becomes, can the partner who knew nothing about the fraud, be held liable, personally, to the Plaintiff (the person or entity suing for fraud)?

No Liability, But It’s Tough to Prove

The answer generally is no; a partner is not individually and personally liable for the wrongs committed by the other partner, and that innocent partner’s assets cannot be touched by the Plaintiff suing.

But this is assuming that the partner had no idea that the fraud was going on, and more importantly, that the partner couldn’t have and shouldn’t have known. A partner cannot remain purposefully and blissfully ignorant of what is going on, and then say that he or she had no idea about fraudulent activity.

Partnerships are closely held, in that there isn’t a lot of management or bureaucracy; there are not a lot of officers, no boards of directors or shareholders, and often, few employees. It is hard to convince a court that you, as a partner, had no idea that your other partner was committing fraud or defrauding people right under your nose.

Partnerships often work under one roof, or else, share books and records and they often make joint decisions on marketing strategies and what contracts to enter into; all things that would lead others to reasonably believe that both partners knew of fraudulent behavior or at least could have known about it and chose to ignore it.

When The Government Sues

It’s not just consumers that can sue for fraud; the government can, as well. And they are going to take the position that all partners knew, and had a hand in, the fraudulent behavior.

You can prove otherwise, but that would be something you would have to convince the judge or jury of, and unless you are completely innocent, the government likely won’t just walk away from punishing a partner.

What About Bankruptcy?

If you do end up owing money because of your partner’s fraudulent behavior, and are driven into bankruptcy because of it, you may be in a tough situation: the Supreme Court has held that for the purposes of discharging debt in a bankruptcy case, all partners are liable for any one partner’s fraudulent activity-and debts related to fraud cannot be discharged in bankruptcy.

Have a fraud case? Call our West Palm Beach commercial litigation attorneys at Pike & Lustig 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