What is a partnership?
The term ‘partnership’ is often used in business, but what does it actually mean? In most cases, it refers to a ‘general partnership’ which is a long established and widely used business structure in the UK.
Unlike a limited company, a general partnership has no separate legal personality from its owners. While it can offer greater flexibility and fewer statutory, administrative and accounting requirements than companies or limited liability partnerships, those benefits come with the drawback that the partners are each jointly and severally liable for the partnership’s debts.
The formation and conduct of a partnership is governed by the Partnership Act 1890 (the Act). The Act codified many existing common law principles relating to partnerships and now defines and regulates partnerships, providing a legal framework for their creation, operation and dissolution. Despite its age, the Act remains a foundational piece of legislation in the UK, even with the introduction of other modern business structures.
Are we operating as a partnership?
The Act states that a partnership will come into existence when two or more persons are carrying on a business in common with a view to a profit.
Some clients, therefore, are surprised to learn that they are, in fact, operating as a partnership. From their perspective, they may have simply started a business with someone else and given little, if any, thought to the legal status of their business arrangement.
Why do we need a partnership agreement?
Most of the Act’s provisions will prevail unless the partners agree to enter into a partnership agreement which overrides some of the default provisions. The Act has been criticised as many of its default provision are widely viewed as outdated and ill-suited to reflect modern business practices.
A partnership agreement does not necessarily have to be written. An oral agreement can be legally binding, but a written partnership agreement is far more desirable because it leaves less scope for disagreement.
Most of the Act’s default rules can be varied by a partnership agreement, but the agreement cannot conclusively determine whether a partnership exists, nor can it alter the statutory position as against third parties dealing with the partnership, particularly in relation to partner authority and partner liability for the partnership’s debts.
What should my partnership agreement include?
Commencement and Duration
A partnership will commence when the legal definition in the Act has been satisfied. However, inserting a date of commencement will provide clarity of when the agreed rights, responsibilities and obligations of the partners commence.
Some partnerships operate during a fixed duration with the purpose of achieving a specific aim or result, and an agreement can be drafted to reflect this. However, frequently partnerships will want to continue operating indefinitely. This is known as a “partnership at will”.
Work Input and Partner Roles
Under the Act, the partners are not strictly required to take part in the management of the business. It is therefore common for an agreement to set out what is required from each partner. A common provision is to state that a partner must devote all their time and attention to the business and not engage in any other business while they are a partner by way of a non-compete clause.
A partnership will function more effectively if each partner is aware of the scope of their duties and responsibilities. An agreement can also place limits on what partners are authorised to do on behalf of the partnership and give the other partners a contractual remedy if that authorisation is exceeded.
Decision Making
The Act provides that most day-to-day decisions of the partnership should be taken by the majority of the partners. However, there are several decisions in which the Act requires unanimous consent which include changing the nature of the business, introducing a new partner, and changing the terms of the partnership agreement.
It is common for a partnership agreement to delegate certain decisions to a single partner to allow for more efficient decision making or to require other types of decision to be made unanimously.
Financial Input and Ownership of Assets
When a partnership begins, the partners will usually contribute a sum of money to enable it to start operating. A partner may have even taken out a loan to finance the partnership.
These initial contributions are classed as the capital of the partnership and should always be set out in the partnership agreement. The agreement should also set out whether a partner is required to contribute more capital in the future.
The partners may also contribute particular assets to the partnership in addition to, or alternatively to, cash. It is important to set out how these assets are owned at the outset. Disputes can arise in relation to partnership property regarding ownership when a partner leaves and the assets are being valued, or where a partner is calculating their tax liability.
Partner remuneration
Partners are the owners of the business and will be entitled to the benefit of the capital profits and income profits of the partnership. Partners will receive the benefit of income profits by making “drawings” from the partnership. An agreement may allow a partner to receive a salary to reflect the work they do, while other partners may not receive any salary but share in surplus profits.
In the absence of a partnership agreement, each of the partners will share equally in the capital and income profits of the business. This can be problematic as often the partners will have contributed different amounts to the partnership. An agreement can provide that the partners should receive capital profits in the same proportions as their initial contributions. The agreement should also specify how income profits should be proportioned (for example, based on working hours).
If a partnership makes a loss, the Act provides that the partners share in the losses equally. An agreement can provide for how losses are to be distributed between the partners.
Expulsion of Partners
The default provisions of the Act provides that no majority of partners may expel another partner from the partnership. This effectively means that it is impossible to expel another partner without an express agreement allowing the other partners to do so.
The grounds and procedure for expulsion should therefore be set out in a partnership agreement.
Dissolution of Partnership
Dissolution marks the end of a partnership. Without a partnership agreement, any partner can dissolve the partnership at any time by giving notice to the other partners. This can force the sale of the business and its assets, require departing parters to be repaid their share of the business, and potentially resulting in the loss of valuable goodwill.
An outgoing partner may also insist that the business is sold rather than allowing the remaining partners to continue trading.
A well drafted partnership agreement can avoid these outcomes by providing for notice periods, allowing the remaining partners to continue the business following a partner’s departure (partial dissolution), restricting retirement during the early stages of the business, and setting out clear buy-out and valuation mechanisms for a departing partner’s interest.
Restraint on trade
An outgoing partner will be free to set up a competing business or to work for a competitor unless a restraint of trade clause is agreed and included in the partnership agreement. This clause restricts an outgoing partner’s business dealings once they leave to protect the partnership’s legitimate business interests. There are various types of restraint on trade clauses.
A non-solicitation clause prevents a partner from soliciting business from the partnership’s existing clients and offering employment to their employees.
A non-dealing clause is more restrictive and prevents a partner from entering into contracts with clients, former clients or employees whether as a result of the former partner approaching them, or vice versa.
How to get in contact
To find out more or if you require assistance with these matters, speak with our Contract Team on +44 (0)204 600 9907 or email info@culbertellis.com.
Accurate at the time of writing. This information is provided for general information purposes only and should not be relied upon as legal advice.
