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Focus on…partnership agreements
The term ‘partnership’ describes a relationship between parties carrying on a business in common with a view to profit. Despite the creation of limited liability partnerships over a decade ago and the availability of other corporate vehicles, the partnership model remains popular, particularly amongst small professional firms who do not wish to be burdened by the legal and administrative requirements associated with incorporation.
The relationship between the partners in a partnership is governed by the agreement between the partners - this can be express or implied, written or unwritten.
The Partnership Act 1890 (the “Act”) forms the basis of modern day partnership law. Although the Act is relatively comprehensive, it does not cover in sufficient detail (or in some cases at all) certain relevant features of partnerships and is in a number of respects outdated. Whilst the Act can form the basis of a partnership’s constitution, it is always advisable for partners to enter into a formal partnership agreement at the outset of the partnership arrangement.
Set out below are some of the important features which ought to be covered in a partnership agreement.
The Act distinguishes between (i) fixed term partnerships which dissolve at the expiration of the term, (ii) partnerships at will or for an indefinite term which may be terminated at any time by notice given by any partner to the other partners and (iii) partnerships for a single venture or undertaking which are dissolved at the termination of the venture or undertaking. As most partnerships are at will or for an indefinite term, the partnership agreement should normally displace the unilateral ability of partners to terminate the partnership by notice and specify how the partnership can be brought to an end.
Capital, profits and losses
Under the Act, partners’ capital contributions to the partnership do not determine their entitlement to partnership net assets or capital - partners are entitled to share equally in the capital and profits and must contribute equally towards losses. Due to the fact that partners’ capital contributions are often unequal and there is often a desire to depart from this default position, the manner in which capital is contributed and the allocation of partnership profits and losses is usually recorded in a partnership agreement.
Relationship between partners
The Act sets out certain additional terms which will be implied in a partnership arrangement but which can be (and often are) superseded in a partnership agreement. These include:
- An obligation on the firm to indemnify partners in respect of payments made, and liabilities incurred, by him in the course of the firm's business or “necessarily done” in preserving the firm’s business or property.
- An entitlement to interest on advances made to the partnership.
- A requirement that every partner takes part in the management of the partnership.
The Act also provides that differences arising as to ordinary partnership matters must be decided by a majority of the partners (although changes to the nature of the partnership business require unanimous partner consent). In practice, a partnership agreement often changes this, and voting can for example be on a weighted basis (in proportion to profit entitlements) rather than per capita.
Death and bankruptcy
The Act provides that a partnership is dissolved by the death or bankruptcy of any partner. A partnership agreement will normally make provision for the partnership to continue after the death or bankruptcy of a partner.
There is no power for a majority of partners to expel a partner from a partnership unless appropriate provision is included in the partnership agreement. Common grounds for expulsion of a partner include partnership agreement breaches, ceasing to hold relevant professional qualifications, conduct having an adverse affect on the partnership business, neglecting to perform duties and ill health.
A partnership agreement should contain provisions dealing with outgoing partners. Conventionally, accounts would be prepared as at the leaving date, on a similar basis to the usual partnership accounts. The outgoing partner is then entitled to the amount due to him as shown in the current and capital accounts. Payments are often made by instalments, thereby assisting the continuing partners in financing the payments to the outgoing partner.
Under the Act, once a partner leaves a firm, he is free to establish a competing business wherever he wishes and can provide services to the firm’s customers or clients. However, he cannot solicit existing clients of the firm or represent himself as carrying on business in succession to the firm or using a similar name. Because of the limited nature of this protection, it is commonplace to include specific covenants in a partnership agreement preventing outgoing partners from dealing with clients or customers of the firm for a period after he has left. There may also be a prohibition on engaging in competing activities within a defined geographical area for a period of time.
As mentioned above, putting in place a partnership agreement can be a crucial tool to the success of a partnership and partners in a partnership would be well advised to consider entering into such an agreement.
If you would like to discuss any of the topics within this blog please get into contact with Agata Rumbelow.
Please note the contents of this blog are given for information only and must not be relied upon. Legal advice should always be sought in relation to specific circumstances.