Guide to partnership agreements

Partnerships involve a group of people working together in a business with the common of making a profit. These relationships are controlled by a partnership agreement (PA) between the partners, which can be express or implied, written, or unwritten.

Partnerships do not have their own legal identity, meaning they cannot own assets, provide security over them, or initiate or defend lawsuits. However, court rules allow partners to sue and be sued in the firm’s name rather than listing each partner individually.

In the case of Hurst v Bryk ([2000] UKHL 19), it was noted that the essence of a partnership lies in the ongoing personal and business relationship, not just the contract itself. However, it’s always a good idea for partners to put a formal PA in place. Although the Partnership Act 1890 (PA 1890) forms the basis of current partnership law and covers most aspects of forming a partnership, it doesn’t address everything, and some parts are outdated. Therefore, it’s advisable to have a formal agreement to ensure all aspects are properly covered.

A PA thoroughly outlines the operational framework, financial management strategies, and mechanisms for dispute resolution within a partnership. It aims to pre-emptively address potential misunderstandings and conflicts, thereby safeguarding the partnership’s integrity and ensuring its smooth operation.

Due to their complexity and their vital role, it’s always recommended that you engage with a law firm, ensuring the agreement is robust and of high-quality. If you require assistance in the creation of a PA, contact us today.

Introduction to partnership agreements

A PA is the legal blueprint for a business partnership. It details the rights, responsibilities, and expectations of each partner, establishing a clear framework for the management and operation of the partnership.

The agreement is crucial for defining the roles, contributions, and profit shares of all partners, as well as setting out the procedures for resolving disputes and making decisions, thereby safeguarding the interests of all parties involved.

The essence of this agreement lies in its ability to provide clarity and direction, ensuring that all partners are aligned with the business’s goals and methods of operation.

Who should use a partnership agreement?

A PA should be used by anyone entering into a business partnership, whether it’s a general partnership, a limited partnership, or a limited liability partnership. This includes new businesses establishing their operational structure, existing businesses introducing new partners, and businesses planning for investment, sale, or ownership transitions.

Are partnership agreements required?

PAs are not legally required but are highly recommended. Without one, partnerships are governed by default rules under the PA 1890, which may not suit the partners’ specific needs or intentions.

A well-drafted PA provides protection for all partners and t helps prevent misunderstandings and conflicts, ensuring efficient functioning of the partnership.

Essentially, while not mandatory, a PA is critical, offering a solid foundation for business operations and partner relationships.

Key terms to include in a partnership agreement

Parties

A PA will be executed among the partners, necessitating clear identification of the parties involved. The agreement will list their names and addresses in the parties clause, which can include individuals, as well as LLPs and companies as partners.

For the purpose of a partnership, every partner acts as an agent of the firm and all other partners. Their actions will bind one another unless both conditions are met they have no authority to act for the firm or the person they are dealing with knows that they lack authority.

Commencement and duration

A PA should deal with the commencement and duration of the partnership. The PA 1890 sets out rules that can be used in determining whether a partnership exists or not.

Determining the actual commencement date of a partnership can be challenging, as it may not align with the date stated or intended by the partners. If business activities commence before the official `Commencement Date` specified in a PA, the partners should consider indemnifying any partner who entered into contracts on behalf of the partnership before that date, with their express or implied consent. This indemnity helps protect the partner from liabilities incurred on behalf of the partnership during the pre-commencement period.

The PA 1890 distinguishes between different types of partnerships based on their duration. Firstly, there are fixed term partnerships that automatically dissolve at the end of the specified term. Secondly, partnerships at will or for an indefinite term can be dissolved by any partner giving notice to all other partners (section 26(1) and 32(c)). Lastly, partnerships formed for a single adventure or undertaking dissolve upon the completion of that specific venture.

However, partnerships at will applies only in situations where the PA does not specify the duration of the partnership. This means that any provision in a PA regarding the termination of the partnership will override the default rule of section 26(1), as established in the case of Moss v Elphick ([1910] 1KB 846).

Partnership details

The agreement should state the partnership’s name and the nature of the business, thus establishing its identity. It is also crucial to specify the place of business., and

Capital contributions

A detailed discussion on capital contributions is vital. This includes not only the initial investment made by each partner but also the approach for any additional contributions that may be required as the business evolves.

Partners are not required by law to contribute equally to the capital of the partnership. However, according to section 24(1) of the PA 1890, unless there is an explicit or implicit agreement stating otherwise, all partners have an equal entitlement to share in the capital and profits of the business.

The agreement should detail the amount and type of capital that each partner brings to the table initially and outline a fair and transparent procedure for future financial injections. This ensures that all partners understand their financial commitments and the process for handling the partnership’s evolving capital needs.

Partnership assets

Ownership and use of assets within the partnership must be clearly defined. This includes specifying which assets are property of the partnership and how these assets are to be used in the operation of the business. It’s essential for preventing disputes over asset use and ownership, especially in the event of a partner’s departure or the dissolution of the partnership.

A general partnership lacks legal personality and therefore it cannot own property directly. Instead, partnership property is typically held by one or more partners on behalf of the entire partnership. If partnership funds are used to purchase property held in the name of a single partner, the PA 1890 presumes that the property belongs to the partnership as a whole, even without an express trust being created.

Therefore, it is important to clearly define which assets are owned by the partnership and which belong to individual partners. This distinction is essential for determining the outcome in cases of insolvency, death, or increases in asset value.

Profit, loss, and distribution

The approach for the allocation of profits and losses among the partners is a key aspect of a PA. It should describe in detail how the partnership’s profits and losses will be distributed and the frequency of such distributions. Additionally, the agreement should set forth the rules governing partners’ withdrawals from the business for personal use, ensuring that the partnership’s financial health is not compromised by personal financial needs.

According to the PA 1890, unless there is an explicit or implicit agreement to the contrary, all partners are equally entitled to share in the profits of the business and must equally contribute to any losses, whether capital or otherwise. Capital profits are included as profits, which applies both before and after the dissolution of the partnership.

Drawings

A PA should determine the amount and timing of drawings. Instead of specifying a fixed amount in the agreement, it may be better to establish a process for setting appropriate levels each year. This could involve creating a budget that estimates the partnership’s income and expenses for the upcoming accounting period. Drawing levels would then be set based on this budget, considering factors such as loan repayments or planned business expansions.

Another important consideration is whether the parties prefer the default position to be that any undrawn profits will be retained by the partnership as capital. If so, this clause should be adjusted accordingly. Additionally, consider whether any funds should be reserved for tax payments, loan repayments, or financing business expansion.

Duties and powers

This clause generally outlines the fiduciary duties partners owe each other, similar to those between trustees and beneficiaries. According to the PA 1890, partners must provide true accounts and full information, account for benefits derived from partnership-related transactions, and avoid competing with the firm.

These rights and duties can be altered with unanimous consent from all partners, but this does not apply to all fiduciary duties implied by equity, as some arise outside the PA 1890. Additionally, the PA may include further duties and powers.

Management and decision-making

Clarifying the authority and responsibilities of each partner, especially in terms of management and decision-making, is crucial. This includes detailing the decision-making process, the allocation of specific responsibilities, and the extent of each partner’s authority in the business’s daily operations.

The agreement should also outline the process for resolving disputes and the voting rights of each partner, typically correlating with their ownership stake. This ensures a structured and democratic approach to decision-making and conflict resolution.

Indemnity and expenses

Unless otherwise agreed, the partnership should include a clause that indemnifies each partner for any payments they make or liabilities they incur in the course of the firm’s business or actions taken to preserve the firm’s business or property. The indemnity provided in this clause usually covers losses resulting from a partner’s breach of the PA.

Salaries and compensation

For partnerships where partners are actively involved in the management and receive compensation beyond profit shares, the agreement must detail these arrangements. This section should outline any salaries, benefits, or other forms of compensation that partners with management duties will receive. This clarity helps to prevent conflicts regarding compensation and recognises the additional responsibilities undertaken by managing partners.

Admission and withdrawal of partners

The procedure for admitting a new partner and the withdrawal or death of an existing partner are key components of a PA. This includes setting forth the criteria for admitting new partners, the process for valuing a departing partner’s share, and the buyout procedures. Such provisions ensure the partnership can adapt to changes in its composition without jeopardising its continuity or operations.

According to the PA 1890, unless the partners agree otherwise, no new person can be admitted as a partner without the consent of all existing partners. It requires either a majority or unanimous agreement to admit a new partner. Upon admitting a new partner, the partnership will become a partnership at will unless the PA provides for the admission of new partners, and they agree to its terms.

Continuance of a partnership

It is also important to address the continuation of a partnership. The PA 1890 states that unless the partners agree otherwise, the partnership will be dissolved upon the death or bankruptcy of any partner. Additionally, any change in the partnership (including incoming and outgoing partners) results in a technical dissolution of the existing partnership and the formation of a new one. To prevent this dissolution, the agreement should include provisions ensuring that such changes do not terminate the partnership.

Retirement, bankruptcy and death

A partner cannot withdraw from the partnership under the PA 1890 or common law unless the PA permits it, or unless all partners agree, or, in the case of a partnership at will, by providing the specified notice. This clause grants partners the right to exit the partnership by giving an agreed-upon notice period.

On the other hand, a partnership is dissolved on the death or bankruptcy of any partner, unless the partners have agreed otherwise in the PA.

Termination and dissolution

Finally, the agreement should specify the conditions under which the partnership may be dissolved and the method for distributing assets and liabilities upon dissolution. This ensures that there is a clear exit strategy for the partnership, providing a structured approach to winding down the business if necessary.

Dissolution of a partnership marks the termination of the partnership relationship, but it does not necessarily mean the winding up of the partnership’s affairs. A “technical” dissolution occurs when partners leave or join, resulting in a new partnership arrangement that continues the business without interruption, maintaining outward continuity.

In contrast, a “general” dissolution typically involves winding up the business and distributing assets after all liabilities are settled. This type of dissolution can occur through unanimous agreement, specific provisions in the PA, or events outlined in the PA 1890, such as mentioned above, expiration of a fixed term or legal impediments to carrying on the partnership’s business.

Additionally, a court may dissolve the partnership based on grounds including a partner’s incapacity, detrimental conduct, persistent breaches of PA, business losses, or for reasons deemed “just and equitable.”

Why should a partnership agreement be in writing?

A written PA clarifies terms, responsibilities, and profit distribution, reducing misunderstandings and disputes. It ensures legal enforceability, providing a solid foundation for business operations and decision-making, thus protecting all partners’ interests.

How to terminate a partnership agreement

To terminate a partnership agreement, you need to review the agreement’s termination clauses and follow the outlined procedures for notification and dissolution. You’ll also need to settle any outstanding debts and distribute remaining assets among partners. If no clause exists, you should follow statutory laws applicable to partnership dissolution in your jurisdiction.

What are the rules when there is no partnership agreement?

When there’s no PA in place, the partnership is governed by default rules under PA 1890.. These rules typically dictate equal distribution of profits and losses among partners, equal management rights, and require unanimous consent for major decisions.

There are a few default provisions you need to consider, including that partners are personally liable for business debts and any partner can dissolve the partnership. These default provisions may not suit all partnerships, highlighting the importance to tailor a PA.

How Moore Barlow can help

Drafting a comprehensive PA is indispensable for the foundation and ongoing success of any business partnership. By covering the essential terms outlined above in detail, partners can ensure a clear understanding of their rights, responsibilities, and expectations. This not only facilitates smooth business operations but also provides a robust framework for addressing challenges and changes, thereby securing the partnership’s longevity and prosperity.

Due to their complexity and their vital role, it’s always recommended that you engage with a law firm, ensuring the agreement is robust and of high-quality. If you require assistance in the creation of a partnership agreement, contact Moore Barlow’s Corporate team today.