Court Holds Death of Original Partner Did Not Trigger Buy-Sell After the Partnership Interest Had Been Transferred to a Trust

In Han v. Hallberg (May 21, 2019), the court of appeal addressed an issue that probably lurks in many buy-sell agreements, including those involving limited liability companies and corporations.

In 1975, four dentists formed a partnership to acquire and maintain a dental office building. In 1994, the then-partners amended their agreement to allow one of the partners, Richard Hallberg, to assign his partnership interest to his living trust, and to substitute the trustee (then Dr. Hallberg) as a general partner in place of Dr. Hallberg individually.

The partnership agreement allowed the estate of a deceased partner the option to retain the interest of the deceased partner by notifying the surviving partners in writing within 90 days of the date of death of the partner of an intent to retain the interest. If the personal representative or the successor trustee of the deceased partner failed to exercise such option by giving timely notice, the surviving partners had the option to purchase the interest of the deceased partner by giving notice to the deceased partner’s estate of the exercise of their option to purchase the deceased partner’s interest in the 60-day period after the 90-day period expired.

When Dr. Hallberg died fifteen years later, his successor trustee did not give notice of an exercise of the option to retain the interest. The surviving partners, however, did give timely notice of the exercise of the option to purchase the interest of Dr. Hallberg. The parties litigated whether, despite the substitution, Dr. Hallberg was still a partner at the time of his death, thus triggering the buy-out provision that applied in the event of a partner’s death. If the trust or the successor trustee, and not Dr. Hallberg, was the partner, then Dr. Hallberg’s death was not the death of a partner.

The trial court noted that the trust was not a separate legal entity. The trial court stated it was required to follow Presta v. Tepper (2009) 179 Cal.App.4th 909, 918, which held that “when a trustee of an ordinary express trust enters into a partnership relationship in his capacity as trustee, it is he, and not ‘the trust’ which is the party to that agreement.” Relying in part on the pick-your-partner principle, the trial court held that Dr. Hallberg, and not his trust, was a partner at the time of his death and therefore the buy-out provision had been triggered by his death.

The court of appeal reversed. As a result of the agreed-to substitution of Dr. Hallberg, as trustee, as a partner in the place of himself individually, the court of appeal concluded Dr. Hallberg was not a partner when he died. His trust, or the trustee of his trust, was the partner. While a trust cannot act in its own name and must always act through its trustee, a trust is a “person” that may associate in a partnership under the Uniform Partnership Act of 1994 (Corporations Code § 16100, et seq.), based on the plain language of the UPA’s definition of “person.” The clear statutory language is reinforced by other provisions of the statute, such the dissociation provisions.

Corporations Code § 16601 provides that a partner is dissociated from a partnership upon the occurrence of certain events. For example, the UPA provides that “In the case of a partner that is a trust or is acting as a partner by virtue of being a trustee of a trust,” a partner is dissociated by “distribution of the trust’s entire transferable interest in the partnership, but not merely by reason of the substitution of a successor trustee.”

The court of appeal noted that language in the partnership agreement that was analyzed in Presta distinguished this case somewhat, but to the extent Presta holds that because a trust is not a separate entity and therefore cannot act except through its trustee, therefore a trust (or a trustee acting for the trust) cannot be a partner, the court in Han v. Hallberg disagreed with Presta and declined to follow it.

Comments

Although this case deals with partnership law and although the General Corporation Law does not define “person” to include a trust, many shareholder agreements have buy-sell provisions that are triggered by death or disability of a “shareholder.” Shareholders often hold their shares in living trusts when entering into a shareholder agreement or transfer their stock to living trusts after entering into a shareholder agreement. Therefore, it is possible that the same issue that arose in Han v. Hallberg, could arise in the corporate context.

Rather than leave to litigation the determination of the effect of the death or disability of a shareholder when the shares are held in the name of a trustee, a buy-sell agreement could directly address whether the death or disability of named individuals (or of a trustee) triggers a buy-sell transaction when the shares are held in the name of a trustee at the time of death or disability. This e-bulletin was prepared by Richard Burt, who practices law in San Jose, California. Mr. Burt is a member of the Corporations Committee of the Business Law Section of the California Lawyers Association.