Why Partnership Agreements are important
A partnership agreement is essential for anyone planning to form a partnership, as well as for those with an established partnership and want to clearly define and protect their legal rights and responsibilities within their business. A well-drafted partnership agreement provides clarity, making future disputes, should they arise, faster and easier to resolve.
A partnership automatically arises under section 1 of the Partnership Act 1890 (“the 1890 Act”), when two or more people are ‘carrying on a business in common with a view of profit’. A minimum of two partners must be involved in order for a partnership to be established. Partners are jointly and severally liable for the debts of the business meaning they all share the burden of profits and losses. How the profits and losses are split is discussed below. The creation of a partnership is that simple.
Its simplicity and affordability often appeal to those wanting to create a business, whether within the family, such as a family farming partnership, or between friends and business partners. The creation of a partnership establishes a business without the need of incorporation with Companies House. Therefore, appealing to some as no formal requirements apply, other than those set out in the 1890 Act. In essence, no formal agreement is required for a partnership to be established and for a business to run. However, the terms set out in the Partnership Act 1890 apply instead by default and these rules may not be best for you and your business.
Many partnerships have already formed and you may just not be aware! You may have already started working within the business and now want to protect your interests by formalising a partnership agreement. The good news is that this is common and you can set this up at any point during the business’ lifetime.
An agreement is desirable as each partnership has their own rules they would like their business to follow. A partnership without an implemented written agreement is called a partnership at will. The detriment of operating without a partnership agreement automatically results in a default agreement being implied under the 1890 Act. Given that this Act was introduced in the 1890’s, many of its provisions can be quite outdated.
For example:
s24(1) of the 1890 Act
A presumption of equality to profits, regardless of contribution, arises. To ensure that your contribution reflects the profit you receive from the partnership, you would need to implement a Partnership Agreement so that this can be clearly established. Not having a Partnership Agreement could mean that you and your business partner would receive equal profits on the money only you contributed to the business.
s32(c) of the 1890 Act
Any partner of the business can dissolve the partnership at any time throughout the course of the business. Without having a Partnership Agreement in place to remove or amend this clause, so as to put restrictions on when the business can be dissolved, the business is vulnerable. This section of the 1890 Act essentially means that if Partner A upsets Partner B, Partner B can end the partnership by dissolving it without ever consulting with Partner A.
Decision-Making
All partners would have equal rights in the decision-making of the partnership even if the contributions made when establishing the partnership were unequal. This may not be preferred as the person who contributed more capital may believe they should have more power over the other partners. For example, if there are younger or new members that are introduced into the business, as soon as they are made partners, they will have equal decision-making rights with those more experienced partners who have been employed for years. To ensure that their decision-making power is given to them gradually, a partnership agreement could include staged shares so they are not given too much power too soon.
s25 of the 1890 Act
The Act provides no clarity on dispute resolution or an exit strategy as s25 implements rules against expelling partners. This means that should a partner not promote the success of a business the other partners would not be able to expel them from the business. As a back up plan, a just-in-case, it would be prudent to have a partnership agreement at the ready to give the other partners the power to expel. Additionally, there is no clause regarding how any disputes would be resolved in the 1890 Act. Therefore, if the situation unfortunately arose, there would be no distinct plan of action over how to deal with the dispute. With a partnership agreement, it could be established that resolution of disputes must first be attempted by arbitration or mediation before court proceedings are commenced. Again, this is more of a just-in-case clause but an important one to have.
s33(1) of the 1890 Act
Every partnership is dissolved by the death or bankruptcy of any partner. Without creating a partnership agreement, your business will simply end should one partner die, or become bankrupt, or leave the business for any reason. This could make the business vulnerable especially if there is a falling out between two partners or something more serious happens. To ensure this does not happen, you can include a clause in your agreement for business continuity despite partners leaving for whatever reason.
A partnership agreement allows you to tailor and introduce provisions agreed upon by all partners, providing the ability to shape and design the rules of the business. Additionally, it is a clear guide for setting out each partner’s rights and responsibilities of the business distinctly. It is important to note, however, that certain provisions set out in the 1890 Act cannot be overridden, or amended, out of an agreement as they are essential provisions to the formation of a partnership in general.
Crucial Clauses
Although you can draft your Partnership Agreement to your business’ needs, there are certain provisions that are essential and should be included in your agreement, under the 1890 Act.
Firstly, a description of the partnership’s details. The name of the partnership and where its main location of business is. These are crucial as it shows from the outset that all partners are on the same page regarding the running of the business and what its intended purpose is.
Secondly, the monetary side of the business would need to be disclosed. For example, how the business is to split profits and losses. It is extremely beneficial for the financial stability of the business to show how the profits and losses are distributed in a business. For this reason, if no provision is made for the sharing of profits and losses, the 1890 Act presumes that all partners agree to share both profits and losses equally. This may not reflect the amount of capital a partner has placed into the business, thus, it would be prudent to ensure the agreed upon distribution is written down for the avoidance of any future dispute. Partners salaries and how often the Partners will take money out of the business are important provisions that must be included for clarity. Additionally, it is not a requirement to make any initial financial contributions, however, if these are made, they must be disclosed.
The decision-making process is something that would be crucial to establish between all partners. For example what decisions need the agreement of all parties or a majority vote? Who will break a deadlock? It is essential these provisions are expressly included in the agreement to prevent any disputes.
Under sections 26, 33 and 34 of the 1890 Act, as mentioned above, a partnership will end if a partner resigns, goes bankrupt, dies or leave the partnership in any way. Therefore, it would be crucial to include a clause in your partnership agreement that the business will continue upon a partner leaving the business in any respect.
Further to these specifics, there are many provisions that should be included in your partnership agreement for the avoidance of any doubt between partners. These include but are not limited to:
- What the business is and how it operates
- Partner’s rights, responsibilities, duties and authority in the partnership
- Allocation of profits, losses, and contributions of any capital
- Any policies your partnership will have (e.g. maternity leave or sick pay)
- How decisions are made, what happens if there is a deadlock, how are disputes resolved (e.g. arbitration or mediation)
- The procedure to introduce or remove a partner, retirement of a partner, ending the partnership etc.
A partnership agreement is a legally binding contract between the partners. We would advise partnerships to prepare or review their agreements regularly, and at the least upon the introduction of new land, assets, or partners.
How can Freeman Johnson Solicitors help?
Often, when a person has created a partnership they are unaware of the legal implications due to its simplicity. As a firm, we, therefore, highly encourage securing your position in the partnership using a partnership agreement.
At Freeman Johnson Solicitors our Corporate and Commercial Department is experienced with drafting Partnership Agreements to your specifications. We are also experienced in company matters and can consider alternative business mediums that may suit your business. If you would like to discuss your matter further with our team please contact us on 01325 466221 or use our enquiry form on our website: Contact Us – Freeman Johnson.
Rebecca Butterfield
Litigation and Corporate & Commercial Team
Freeman Johnson Solicitors
11 Victoria Road, Darlington, DL1 5SP
Telephone: 01325 466221