What Creditors Don’t Know Can’t Help You: Indiana Court of Appeals Holds Ex Spouse Liable for Business Debt
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In a published opinion, the Indiana Court of Appeals taught a costly lesson to the former spouse of a business owner, and it’s one everyone involved in a small business (and their creditors) should heed. By failing to notify his former spouse’s landlord that his partnership with her had dissolved, an ex-husband became liable for more than $28,000 for a lease extension his ex-wife signed after filing for divorce. Curves for Women Angola v. Flying Cat, LLC, No. 76A04-1206-PL-312 (Ind. Ct. App. Feb. 26, 2013).
I. Marriage, Partnership and Business
Curves begins happily enough in 2001. Dan Cole and his then-wife Lori executed a franchise agreement with Curves International, Inc. and started a business called Curves for Women of Angola. The agreement identified them as “principals of the corporate or partnership franchisee,” and both Dan and Lori signed. Around the same time, Dan and Lori leased space for the business from a predecessor in interest to Flying Cat LLC. Dan and Lori both signed the lease as “owners.” The lease had a three-year term with an option for two additional three-year terms.
Over the next several years, both the business and the marriage began to break down:
- In late 2004, Dan and Lori exercised their option for the first three-year lease extension on behalf of “Curves for Women of Angola.”
- On May 4, 2007, Lori filed a petition for dissolution of the marriage.
- By the end of 2007, the business was $21,641.55 behind on the lease.
- On January 1, 2008, Lori and the landlord exercised the second three-year renewal of the lease, again on behalf of “Curves for Women of Angola.” This time, Dan did not sign the extension. But neither he nor Lori told the landlord about the divorce, or that he and Lori were no longer in partnership with each other. The landlord believed that Lori was signing on behalf of the partnership.
- By August 2008, the business was still behind on the lease. The landlord set up a repayment schedule, but the business soon fell behind again and owed more than $44,647.39 in back rent and fees by the end of 2010.
- In 2011, Lori sold the business. Dan, still a franchisee under the franchise agreement, signed the necessary documents to authorize the sale.
In the meantime, the landlord filed suit in 2010 against Dan, Lori and the business. It quickly obtained default judgment against Lori and the business – neither responded to the lawsuit – for $49,945.03. (The opinion does not explain the increase, but it is likely due to a combination of additional rent, interest and penalties, and contractual attorney fees.) The trial court soon entered partial summary judgment against Dan for the arrears as of December 31, 2007, the day before Lori signed the second lease renewal. Dan’s liability for the remainder of the debt, arising from an extension Lori signed after filing for divorce and after the business partnership dissolved, was the only dispute remaining and the central issue on appeal. After a bench trial in 2012, the trial court held that Dan was liable, and the Court of Appeals affirmed the judgment.
II. Partnership and Debt
Dan’s argument on appeal that he was not liable under the lease extension took two parts: that he was not in partnership with Lori, and that even if he was, he was not liable for the second lease extension, which Lori had signed alone. The Court of Appeals rejected both arguments.
A. Dan and Lori operated the business as a partnership.
First, the Court of Appeals affirmed the trial court’s finding that Dan and Lori operated the business as a partnership. As defined in the Indiana Code, a partnership is “an association of two (2) or more persons to carry on as co-owners a business for profit and includes for all purposes of the laws of this state a limited liability partnership.” Curves, slip op. at 6 (citing Ind. Code § 23-4-1-6(1)). A partnership requires a voluntary association between the parties for the purpose of sharing profits and losses, the court continued, and intention by the parties to form a partnership. Id. Intent to form a partnership is determined by examining the facts of the case, id., but subject to certain exceptions (such as wages or rent), “receipt by a person of a share of the profits of a business is prima facie evidence that the person is a partner in the business.” Id., slip op. at 7 (citing Ind. Code § 23-4-1-7(4)) (emphasis omitted).
Dan argued that he and Lori had not shared profits, so the trial court had erred by finding that they were partners. The Court of Appeals disagreed. It held that no “set formula” for profit sharing was required to establish a partnership, and that the business profits “shared in the profits as a general marital asset.” Id., slip op. at 8. And it noted that Dan and Lori had signed the original franchise agreement as principals of the franchisee; that Dan had paid the first six months’ rent; that Dan had provided services to the business; and that he had shared in business profits. In light of these facts, the court concluded, “the trial court could reasonably find that Dan and Lori operated Curves of Angola as a partnership.” Id., slip op. at 9.
B. Dan was liable for the second lease extension – even though it was executed after the divorce – because he did not notify the landlord that the partnership had terminated.
The trial court in Curves found that the partnership terminated on May 4, 2007, when Lori filed for divorce. Still, the trial court found, and the Court of Appeals agreed, that Dan was liable under the lease extension that Lori had signed alone on January 1, 2008.
This was so because Lori would have had authority to bind the partnership had it not dissolved, and no one had told the landlord that it had dissolved. On this point, the Indiana Code is clear: Subject to certain exceptions, a partner can bind a partnership (making other partners liable) by any transaction that would have bound the partnership had it not dissolved, provided that the other party had either extended credit before the dissolution and had no notice of the dissolution, or had known about the partnership before dissolution, had no notice of the dissolution, and the partnership had not published notice of its dissolution. Curves, slip op. at 9 10 (citing Ind. Code § 23-4-1-35). Because (a) Lori had authority to bind the partnership before it dissolved, (b) nobody notified the landlord of the dissolution until after Lori had signed the extension and (c) the dissolution had not been published in a newspaper and there was no other evidence the landlord knew about it, Dan, as a partner, was liable. Id. at 11.
III. What Does it Mean?
This case reinforces the principle that it is possible to “fall into” a partnership and become bound by the acts of others, perhaps without realizing it. If you’re involved in a business venture with someone else, it’s important to know exactly what your rights and obligations are. And it’s just as important, when the venture ends, to take appropriate steps to ensure that your past partnership does not come back to haunt you. Had Dan notified the landlord, as soon as Lori filed for divorce, that the partnership had dissolved, he probably would not have been liable for the 2008 lease extension.
But suppose Dan and Lori had formed a limited-liability entity like an LLC. Would the result have been different? Maybe, maybe not, and there lies what I think to be the broader lesson in this case.
As a general rule, a limited liability entity like an LLC or a corporation shields its owners from personal liability for the entity’s debt. If Dan and Lori’s business had been an LLC, and the LLC alone had signed the lease extension, neither Dan nor Lori would have been liable for the rent (except under special circumstances this article won’t get into). But there’s a catch: landlords, banks and other creditors also understand this principle, so they commonly require “personal guaranties” from creditworthy individuals, usually but not necessarily the business owners themselves. Those guaranties require the individuals signing (the “guarantors”) to pay the debt if the business does not.
So now we’re back to Square One. Had Curves of Angola been an LLC, and the landlord had been wise enough to demand continuing personal guaranties from Dan and Lori, this case would have been governed by different laws but similar principles. Under a continuing guaranty, the guarantor is generally liable for all debt under the guaranty whether or not it existed when the guaranty was signed. If the guarantor properly terminates the guaranty, he or she is liable for the debt then existing, but not for any future debt. But until the guarantor does that, he or she is liable for all debt under the guaranty.
In fact, a continuing guaranty may apply to new debt that can be incurred more often than we see in Curves, where the new debt was a single lease extension under an existing option. A trade line with a supplier, for example, incurs new debt every time the supplier delivers goods or provides services. A revolving line of credit with a bank incurs new debt each time the borrower draws on it. In both cases, a guarantor’s potential liability can grow at any time, often (under a typical guaranty) without particular notice to the guarantor.
All of this means that whether you’re in a partnership, as in Curves, or have simply guarantied some small business debt, it is important to understand your obligations and how to limit your exposure to the business’s creditors once you are no longer involved. Ending the personal or business relationship with the other person may not be enough.