Question two

Ever since he was a small boy Nephew has dreamed of owning a car repair business. Following high school, Nephew borrows money from Bankco and enrolls and pays his own way through Tertiary Trade School. Three years later he graduates as a skilled and licensed car mechanic with a sizeable debt to the bank. All that stands between Nephew and fulfillment of his dream is an absence of capital.

Nephew approaches his favourite Uncle and favourite Auntie and asks for their help in financing his dream. After some discussion it is agreed that each of Uncle and Auntie will put up $15,000, each of Uncle and Auntie will receive 15% of the profits of the proposed car repair business, and that each will receive back their $15,000 at the end of three years. Uncle and Auntie are to have no voice in the running of the business.

Cashed up in this fashion, Nephew rents a small garage and soon commences a car repair business trading under the name Nephew's Car Repairs.

How should we categorise the relationship that now exists between Nephew and his two relatives? On the information available there would appear to be two possibilities.

Option 1: Nephew, Uncle and Auntie are now partners in a car repair business. Nephew is an active partner while Uncle and Auntie are sleeping partners. The partnership rather than being established for an indefinite period has an agreed life of three years and will automatically be dissolved at the end of three years at which time the sleeping partners are to receive back their capital contribution.

Option 2: Nephew is a sole trader. The relationship between Uncle and Auntie on the one hand and Nephew on the other hand is creditor and debtor. Uncle and Auntie are lenders and Nephew is a borrower on a term loan of three years.

Two questions follow:

(a) If this is an option 1 story then Uncle's personal wealth and Auntie's personal wealth is at risk. This is in consequence of s.10. Suppose however the partnership agreement provided that while firm profit was to be split 70-15-15, all firm losses were to be borne solely by Nephew. Would such a provision in the partnership agreement protect Uncle and Auntie from the risk presented by s.10?

(b) Suppose the parties intend an option 2 deal. Would a court accept that in truth the relationship between Uncle and Nephew is that of creditor and debtor (and likewise re Auntie and Nephew)? After all, s.3(c) states: '... the receipt by a person of a share of the profits of a business is prima facie evidence that he is a partner in the business ...'.