Short answer. The law imposes a double penalty. Under the Civil Code, a capitalist partner who competes with the partnership in the same type of business must turn over to the common funds any profits he earned from the competing business, and must personally absorb all the losses from those transactions. The partnership keeps the gains; he keeps the losses.
What the law says
Any capitalist partner violating this prohibition shall bring to the common funds any profits accruing to him from his transactions, and shall personally bear all the losses.
Civil Code, Article 1808 — Capitalist Partner's Competition. Read the full provision →
The prohibition and when it applies
Article 1808 prohibits capitalist partners from engaging for their own account in any operation of the same kind of business as the partnership — unless the articles of partnership expressly permit it. A capitalist partner is one who contributes capital (money, property) to the partnership, as opposed to an industrial partner who contributes services. The prohibition covers direct competition: if the partnership deals in construction materials and the partner quietly opens his own construction materials business, he has violated the rule. The "unless there is a stipulation to the contrary" clause means the partners could agree in the articles to allow outside activities — but absent that clause, the prohibition is automatic.
What the penalty does — and why it is calibrated this way
The penalty is deliberately asymmetric. Any profits the erring partner earns from the competing business go into the partnership's common fund — the other partners benefit from the gains he generated outside. But any losses from the competing business stay with the erring partner personally — he cannot offset them against his partnership account or drag the other partners into bearing them. This design discourages competition by ensuring the partner can never profit from it: good outcomes are shared, bad outcomes are his alone. It removes all financial incentive to compete.
The competing business does not need to cause harm
The violation occurs from the moment the capitalist partner engages in the competing business without authorization — the partnership does not need to show that it actually lost customers, revenue, or contracts to the competing enterprise. The prohibition is preventive, not remedial. A partner who says "my side business never actually hurt us" is still in breach. The obligation to turn over profits and absorb losses follows from the act of competing itself, not from proof of damage.
Steps the partnership should take
Once the competing activity is discovered, document it thoroughly: dates the competing business was operated, revenues it generated, the nature of the work, and any overlap with the partnership's clients or projects. Demand an accounting of the profits earned. If the erring partner refuses, the partnership may need to seek a court order compelling the accounting and the transfer of profits. The partnership should also consider whether the breach is serious enough to warrant dissolution or expulsion depending on how the articles of partnership are written. Early legal advice will help the remaining partners understand their options before the situation becomes more entrenched.