Partnerships are one of the many forms of business vehicles available to those looking to go into business with others.
It is common for partnerships to be formed at a time when there are significant financial outlays of starting a business, so having a partnership agreement drafted may not be an appealing prospect. However, boring as it may sound, it is immensely important to have a legal partnership agreement in place to ensure fair distribution of profits and rules governing the partnership to reflect the partners’ wishes.
General partnerships and the Partnership Act 1890
When a general partnership is created the partners are jointly and severally liable and the partnership is not known as a separate legal entity as a limited company would be. Personal liability is imposed on the partners for liabilities incurred by the partnership.
The Partnership Act 1890 will apply to the extent that the partnership agreement does not provide for the matters that are required of partnerships pursuant to the Act. It is quite common to find that partnerships formed many years ago will fall into this ‘general partnerships’ category because partnership deeds were not usually signed at the time when it was created.
As partnerships grow, the need to protect the partners becomes even more imperative.
Limited Liability Partnerships (LLPs) and the Limited Liability Partnerships Act 2000
Forming an LLP creates a legal entity separate from the partners and that entity is responsible for the liabilities of the partnership.
The Limited Liability Partnerships Act 2000 includes default provisions for these types of partnerships and if your partnership does not have an agreement in place, this Act will apply.
Intentions of setting up a partnership and profit share
A partnership agreement can set out the intention of forming the partnership. This can be helpful if it is intended to be set up only for a short or fixed term – the provisions therein would reflect this.
For members of general partnerships and LLPS, the default position is that each partner is entitled to equal shares of the profits. If some partners work harder than others or have invested more into the partnership, this may not be desirable. In such case, the agreement should reflect that the partners are entitled to different profit shares.
Depending on the relationship and roles of partners, it may also be appropriate to designate salaries and set out each partner’s investment.
Roles and Responsibilities
Partners share the responsibility for business decisions and matters affecting its day-to-day running and consequently have the right, but not responsibility, to contribute towards it.
If a partner wilfully neglects the business, the other partners can seek compensation from him or her.
An agreement can set out the roles and responsibilities of individual partners, to avoid disputes and the costs associated with it.
Voting and Decision Making
For general partnerships and LLPs, the equal stake each partner is assumed to have put into the partnership, provides each partner with equal voting rights under the legislation. This can be altered by the agreement and may be appropriate where some partners have invested more than others or otherwise make different contributions towards it.
If no provision is made for the proportion needed to pass a vote in the partnership agreement (or there is no partnership agreement in place), a simple majority is provided for in legislation. This applies unless the decision will change the nature of the business or concerns the introduction of a new partner into the partnership. In such cases, the partners must be unanimous with their votes. If the partners want a greater or lesser proportion to pass such a vote, the partnership agreement should reflect it.
When disputes arise between partners, the options are to either resolve the dispute or dissolve the partnership. In a bid to retain the partnership and relationship between the partners, the partnership agreement can provide that the partners must undergo mediation or another form of dispute resolution to try and reach a resolution before dissolving the partnership.
Termination and Dissolution
Under the default provisions of the legislation governing partnerships, members of general partnerships cannot leave; the whole partnership must dissolve. The partnership must be dissolved and the assets distributed. If some of the partners intend to carry on, having a partnership agreement in place with the relevant provisions can enable this. The partnership could then only be dissolved according to the terms of the agreement and only after following the provisions allowing the other partners to continue the partnership.
Members of LLPs can leave and be replaced by new members, as long as Companies House is informed. The agreement should state whether the partnership is dissolved if partners withdraw, either voluntarily or involuntarily (due to incapacity). If there is to be a special procedure and circumstances for ending the partnership, for example voting, this should also be included. For example, it may be intended that the partnership be for a fixed term, the lifespan of the partners, end when one or more partners give notice to terminate the partnership or when a particular event occurs, such as death or retirement.
Regardless of whether the partnership is a general partnership or an LLP, there also needs to be provision for how assets will be distributed upon dissolution, if this is not to be equal distribution. Otherwise, LLPs are dissolved by a majority of partners, two remaining partners, or a sole remaining partner applying to be struck off the register.
The death of a partner in a general partnership dissolves the partnership completely. However, a partnership agreement can provide that the partnership will not dissolve upon death, unless there are only two partners. This is recommended because it can be immensely stressful on the remaining partner to have to wind up the business, finish the current contracts and pay off the debts, especially when the business is otherwise running prosperously.
If there are only two partners, there can be arrangements made so that the business can be carried on by the remaining partner, or if there are more than two partners, that the partnership simply continues.
An LLP will survive the death of a partner, but provision needs to be put in place if the partnership consists of only two partners.
New partners in general partnerships do not become liable for the partnership’s old debts, they only incur liability for debts accumulated after joining. The new partner will also be entitled to an equal share of profits from this point unless the agreement states otherwise.
Often the current partners will use a vote to determine if a new partner will join. The procedure for this should also be included in the agreement.
LLPs should have provision in the partnership agreement for the entitlements, rights and responsibilities for new partners if these are intended to be different from the default in legislation.
Ensuring the partnership is working effectively
If there is a dispute which cannot be resolved and a partner is being difficult about leaving, the partnership would need to be dissolved. This is because general partnerships and LLPs cannot expel members if they do not have their own partnership agreements. An agreement can provide for expelling members in certain circumstances if this is necessary to get the business back on track.
Having a well-drafted partnership agreement means the partners have much more freedom in how they run their partnership. An agreement allows their legal rights and obligations to cater to the reality of how the partnership was created, the investments made and the reality that all possibilities need to be accounted for. The other advantage is that there will be fewer opportunities for disputes because the partners have already set their own rules and procedures. This can save legal fees and litigation down the track. So as you can see, advance planning is the key.
If you would like assistance with drafting a partnership agreement or legal advice regarding a partnership, please contact us on 020 3588 3500 to speak to one of our solicitors or click here.
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