## Facts

- Knauth, Nachod & Kuhne (K.N. & K.), a banking and brokerage firm, faced serious financial distress after speculative investments.
- Peyton and other wealthy lenders entered a June 4, 1921 rescue financing documented in an agreement, an indenture, and an option.
- The lenders supplied about $2.5 million in securities, enabling K.N. & K. to borrow roughly $2 million in cash from banks using those securities as collateral.
- In exchange, the lenders received a contractual right to 40% of K.N. & K.’s profits until repayment, plus collateral including firm securities and a life insurance policy assignment.
- Two lenders were designated as trustees to hold pledged securities, with authority to buy, sell, and substitute collateral, while keeping it separate from the firm’s assets.
- The trustees had informational and protective rights, including inspection of books and veto power over specified speculative transactions that could endanger the collateral.
- The instruments restricted partners’ draws and barred other profit distributions while the financing remained outstanding; partners assigned their partnership interests as security to the trustees.
- The lenders obtained an option to purchase up to 50% of the partners’ interests at set prices, with a possible later corporate reorganization.
- The instruments expressly disclaimed any present partnership and described profit participation as compensation for the financing.
- A creditor, Martin, sued claiming the lenders were partners in substance and thus personally liable for K.N. & K.’s debts.

## Issues

1. Whether an agreement granting lenders profit participation, extensive protective rights, and a future option to acquire an ownership interest created a present partnership under New York Partnership Law.
2. Whether the lenders’ inspection and veto rights amounted to managerial control consistent with co-ownership of the business.
3. Whether profit sharing in this context should be treated as evidence of partnership or as compensation for a risky loan.

## Decision

- The New York Court of Appeals affirmed judgment for the defendants.
- The court held the arrangements did not create a present partnership between the lenders and K.N. & K.
- The lenders were secured creditors, not co-owners, and were not liable for the firm’s debts.

## Legal Principles

- Partnership is a consensual relationship arising from contract, express or implied; where a complete written agreement governs, the court determines whether it creates a partnership.
- Disclaimers of partnership are not controlling if the agreement as a whole establishes co-ownership of a business for profit.
- Receipt of a share of profits is significant but not dispositive; it may represent compensation such as interest or payment for assuming lending risk rather than an ownership interest.
- Creditor protections (information rights, inspection, and vetoes aimed at safeguarding collateral) do not establish partnership absent a transfer of managerial control or co-ownership.
- A contingent option to acquire an ownership interest in the future does not itself create a present partnership.
- Absent partnership by estoppel, only those who are partners between themselves are liable to third parties for partnership debts.

## Conclusion

The court treated the transaction as secured rescue financing: profit participation and strong protective controls were consistent with creditor status, and the unexercised option to buy into the firm did not convert the lenders into present partners liable for the firm’s obligations.


Martin v. Peyton, 246 N.Y. 213, 158 N.E. 77 (N.Y. 1927)