Partnerships are useful vehicles for individuals and businesses that wish to work together to achieve a common commercial objective. Indeed, the very definition of a partnership is an arrangement between two or more people for the carrying on of a business in common with a view to making a profit. It is, however not uncommon for partnerships to often hit the rocks, especially where there is a difference of opinion regarding the direction of business. Below we consider some of the basic steps that can be actioned to limit any such fall out and what you should be considering before entering into a partnership agreement.
The main rules governing partnerships’ conduct of business and management are set out in the Partnership Act 1890 (“the Act”). Yes, it’s that old. The Act is far from comprehensive and has failed in general to move with the times. As a result, the gaps it leaves are best covered by a formal, written partnership agreement. Indeed such an agreement is essential to overcome a provision of the Act that provides for a partnership to be dissolved automatically on the death of a partner. Without an agreement, often in such circumstances all bank accounts are frozen and business can no longer be conducted.
Trust and Good Faith
Trust in a partnership is vital to its success. It is essential that the partners trust each other as each has ostensible authority to bind the partnership. The law imposes an obligation on partners to act with the utmost good faith in their dealings with or concerning each other, including financial matters. In return, a partner is entitled to an indemnity from the partnership for all debts or claims they incur for the purposes of or in connection with the business of the partnership. It is, however, important to note that partnerships can be a party to a claim made in the Courts without it being necessary to claim against partners individually.
A well drafted partnership agreement will provide for how all administration and conduct of business are carried out. The agreement will include provisions for admission, expulsion and retirement of partners, and the authority of partners to bind the partnership. There will be provisions for the resolution of voting deadlocks and restrictions on the commercial activities of partners once they have left the partnership. These will be the same as or similar to restrictions in employment contracts, but are more likely to be enforced by the Courts because of the commercial nature of the relationship between partners. Without such provisions, disputes can often arise, especially in voting deadlock scenarios.
For the reason stated above, and as much as we would like to think it would never happen, a partnership agreement should also provide for the continuation of the partnership after the death of a partner.
Partnership agreements, should also consider the timeframes involved. If it is intended that the partnership is only formed for a particular purpose or for a specific period of time, it will terminate when the purpose is satisfied or the time has expired. This should be clearly stated in the agreement.
To finance the business, partners inject capital into their capital accounts in the books of the partnership and their share of profits and losses are credited or debited to their revenue accounts. Each partner is separately liable to HMRC for income tax on their profit share.
Property, such as offices or a factory, used for the purposes of the business of the partnership can be dealt with in various ways. First it could be owned by some or all partners personally and leased to the partnership. If the property is leasehold then freeholder’s consent or licence will be needed. Technically a conflict of interest may arise if a partner is both owner and tenant but this is easily addressed by the consent of other partners to the arrangement being recorded in minutes of a meeting of partners. Secondly they can introduce it to the partnership as an asset and partners’ shares in its value would be credited to their capital accounts.
The type of partnership described above is known as a general partnership. Partners in a general partnership are liable for partnership debts and commitments to the full extent of their personal fortune. Partners should seek to cover this liability with insurance.
In 2006 the concept of a limited liability partnership was created by statute and has proved to be very popular. Unlike general partnerships, these need to be registered with the registrar of companies, and there are more reporting regulations imposed on them. The liability of partners is limited to what they have put into it, and no more unless they are fraudulent, otherwise they have much in common with general partnerships.
In all cases, however, a well drafted partnership agreement is essential.
These notes have been prepared for the purpose of articles only. They should not be regarded as a substitute for taking legal advice.