US President Dwight D Eisenhower is quoted as saying “farming looks mighty easy when your plow is a pencil, and you’re a thousand miles from the corn field”. The same can be said of a farm partnership agreement.
It may seem a simple straight forward document but unless you fully understand the farming business in its context and the family dynamics of the partners that make up the partnership, the agreement itself could be a thousand miles away from what’s actually happening on the ground.
Not only is this playing with fire when it comes to the availability of Agricultural Property Relief and Business Property Relief for inheritance tax, but it also raises the risk of disagreements that could result in a highly expensive legal court case. “Those preparing such agreements” commented Lord Justice Briggs of the farming case of Ham v Ham “will take note of the anxiety, expense and delay” that not having a well drafted partnership agreement can cause.
What should you look out for in your own or your client’s partnership agreement to make sure it is fit for purpose?
- Starting with the basics, you don’t necessarily have to have a written partner- ship agreement to be in partnership. So, the first question must always be; is there a written partnership agreement signed by all the current partners? If not, are you really going to gamble your family’s future on an Act of Parliament now over 120 years old? If an agreement does exist, make sure the accountant, land agent and lawyer have a copy.
- It goes without saying that a farm needs land; there needs to be land, be it a barn, field or wood, in order to farm it. Yet that does not necessarily mean the farming partnership has to own the land. The land could be let to the partnership, there could be a licence for the partnership to occupy the land and the partnership could own the land. All of these options have implications for tax and associated reliefs and also for the continuance of the business on the death of a partner. Does your partnership agreement, accounts and other legal documentation accurately reflect the land ownership?
- Has the partnership paid for improvements to the property? How has this been reflected in the partnership agreement and the accounts? This is particularly important when partnership money has been used to make improvements to the property when the land itself is owned by one of the partners. Examples might include a new agricultural building being built on the land or a new drainage system being installed on the farm.
- How are income profits and losses divided between the partners? Again, there are a number of ways this can be done from a straightforward division to reflect the capital contributions, to a division in accordance with how much work is undertaken by a respective partner, to the use of preferential shares. The important point is that there is a clear note on how profits and losses are calculated and how they are divided.
- It’s not only income profits but capital profits that also need to be considered. In other words, the increase in value of the asset from when it was acquired by the partnership. How would the sale proceeds be divided if the partnership sold a small area of the farm for development for example?
- Most businesses of more than one person will have some sort of management process and a degree of delegation. A farming partnership is no different. Clearly for a partnership of two people, say husband and wife, the management process and delegation is fairly simple and happens without too much thought. Beyond that, however, particularly for a partnership with multi-generational interests, there is a need for thought, consideration and adoption within the partnership agreement.
- It comes as quite a shock to a lot of clients when they realise that without a written agreement which specifically excludes s33 of the Partnership Act, 1890, on the death or retirement of a partner the partnership automatically dissolves. Does your written agreement take this into account? As was seen in the farming case of Kingsley v Kingsley (2019) without robust documentation in place considerable problems can occur for the family left behind when a loved one dies.
- Are there appropriate mechanisms in place to value the assets of the partnership on the death or retirement of a partner?
This is of particular note if land is owned by the business. Is the value to be used the value shown in the accounts, the agricultural value or the open market value? What if there is a dispute over the valuation? Following on from this, if there is an option for the continuing partners to buy out the outgoing partner’s share in the business is the payment to be made in one go or by instalments over several years?
- Does the agreement give the appropriate delegation authority if a partner suffers from mental incapacity?
Or put another way, does the incapacity of a partner prevent the partnership from functioning? Not only is the average age of farmers increasing but generally farming is a hazardous industry and sadly accidents and injuries do occur. Is your partnership agreement robust enough to deal with these changing family circumstances?
- Do all the partners fully understand the partnership agreement?
No matter how well the partnership agreement is drafted, if the parties do not understand what they are entering into then it has the potential to fail. Time spent considering and preparing a partnership agreement is time worth spending. There is a tendency to think that these agreements are straight forward and, since it is family, any issues would be dealt with around the kitchen table. Yet they are often not that straight forward and part of the role of the professional is to challenge this view and get the family to consider scenarios that they may not have thought of, or have considered would arise.