What is a Business Partnership?
Commonly a business partnership is defined as “a relationship between two or more parties carrying out business with the common view of making a profit” (s.1(1) Partnership Act 1890 – the ‘PA’). The PA does not distinguish between actual and legal persons; so a company is able to be a partner.
Whether or not a partnership exists in the eyes of the law is determined on the circumstances of the case. As a result, Partnerships arise frequently even when they are not intended.
A Partnership Agreement formalises a Partnership and will usually contain the following information:
Division of profits
Division of losses
Confirmation of contribution amounts/ownership percentages
- Partner’s mutual rights and obligations, these can normally be altered by agreement (default position is that unanimous consent is required – s.19 Partnership Act 1890)
- Appointment of new Partners
- Partnership Termination clauses
- Mediation or arbitration clauses (methods to resolve disputes before dissolution)
- Process for partnership dissolution
- Buy/Sell out provisions
- Distribution percentages of capital upon dissolution of the partnership
- Provisions for incapacity or death
What happens if we do not have a Partnership Agreement?
Business Partnership Disputes can become complicated and messy without a Partnership Agreement in place. The Partnership Act 1890 does contain some basic default positions to be used in the absence of a written agreement.
- s.24 PA provides default provisions regarding Partnership finances. For example, under s.24(1) where Partners have made unequal contributions to the capital of the Partnership, there is an implied agreement that on dissolution they can take this capital back proportionally to their original contribution. However with regards to profits and losses there is no such implied agreement. Consequently, without a Partnership Agreement in place profits and losses are divided equally.
- Without a Partnership Agreement, a Partner is not entitled to take a salary from the Partnership.
- Partnership property is another common cause of Partnership disputes. In the absence of any agreement, s.20 PA dictates that any property brought into the Partnership belongs to the Partnership. Therefore without any prior agreement as to how this should be divided upon dissolution, it will be distributed equally.
Do we need a Business Partnership Agreement?
As you can see, formal agreements are particularly important where partnership disputes arise. Without an agreement Partners are treated equally and not infrequently Partners find themselves stuck over a partnership dispute, deadlocked over an issue, unable to reach any decision. A Partnership Agreement can include provisions to avoid this, thus avoiding a dispute.
A Partnership Agreement is not only fundamental for financial reasons but is also a useful tool when a Partnership falls apart. Crucially if there is no Partnership Agreement to dictate the terms of a Partner’s termination, if one Partner leaves, the Partnership is automatically dissolved.
What liabilities do I have in the Partnership?
Every Partner has a joint contractual liability with the other Partners for all debts and obligations incurred in the Partnership’s name. This means that if a client sues the Partnership for the performance of their contract, then every Partner is jointly liable.
Every Partner also has a joint and several liability for the negligent actions of another Partner. Therefore if a Partner acts negligently, the injured client can sue any of the Partners for damages. If the negligent Partner is sued by a client, that Partner can then seek a contribution for damages from the other members of the Partnership. Each Partner is therefore severally liable for the whole amount in this case.
It’s particularly important for any partner to be aware that in the absence of a partnership agreement to the contrary, their liability for partnership losses or debts extends to their own personal assets – which is why it is so very important to ensure that there is a written partnership agreement setting out the separation of each partner’s own finances from that of the business.
What happens when a Partner retires?
In the absence of a Partnership Agreement or Limited Liability Partnership, a Partner cannot simply retire or leave without effectively dissolving the Partnership. Although a new Partnership can then be re-created, this does have tax implications.
Nevertheless generally speaking the retiring partner is entitled to remove his/her capital from the business when they retire. However, their obligations towards the Partnership do not end there. The retiring Partner remains liable for the old debts of the Partnership unless something to the contrary is agreed before they leave.
If there is a Partnership Agreement in place then the terms of this should be checked so that the retiring Partner can ensure that he/she is leaving via the correct procedures.
What are the advantages of forming a Partnership?
There are several advantages to forming a Partnership. These include:
Each Partner is able to specialise in their own area of business and therefore a combination of Partners tend to offer a broader range of services.
Finance is easier to raise than when acting as a sole trader.
No corporate registration fees as with a company.
No legal formalities are strictly necessary.
Partners can flexibly work to cover each other during periods of absence or sickness.
Partnership Agreements ensure that Partnerships are created with safeguards protecting each Partner involved.
Sleeping Partners can inject equity when necessary without having control over the business.
What are the disadvantages of forming a Partnership?
There are some disadvantages of forming a Partnership. Some of these can be avoided however by using a well drafted Partnership Agreement. The major disadvantages are:
Each Partner is self-employed and must therefore submit self-assessment tax returns annually.
Profits are taxed as individuals not via corporation tax.
Each Partner must pay National Insurance contributions.
Partners are jointly liable, therefore creditors can come after any Partner to settle debts due.
Creditors can also seek to settle from a Partner’s personal assets.
What are the most common causes of disputes in business partnerships?
There are lots of different reasons why there might be a dispute in a partnership. Some of the most common reasons are:
- Fundamental disagreements over the day to day running or the general direction the business should be taking
- Issues surrounding partnership tax, or about assets used by the business which own to one or more than one of the partners
- Disputes arising when one of the partners is expelled from the partnership
- Disputes surrounding attempts to suspend or get rid of a partner who is performing poorly. This is one of the most common issues and often boils down to partners feeling that not everyone is making an equal contribution.
- Arguments about the payment of profits which are being claimed by one or more than one partner.
- Arguments surrounding the value of the share owned by a partner who has died, retired or has been expelled
- Arguments regarding the suspicion one partner is making a secret profit from the business without informing the others
- Disputes at the time of dissolving the partnership. This could include one ex-partner carrying on with the business but without the consent of the others
- Issues regarding enforcement of any restrictive covenants against a partner who is leaving
- Arguments about capital investments in the business. Most partnerships involve people who have invested different levels of money into their business. Given that the Partnership Act says that if there is no written agreement everything has to be shared equally, this often causes a dispute.
What are the available outcomes for Partnership Disputes?
There are three main ways of getting a solution when there is a dispute between business partners.
• Resolution – the simplest method is to talk through any dispute between business partners as soon as possible to try to come to an agreement. Mediation can be hugely beneficial during this process.
• If an agreement cannot be reached, the partnership might ultimately be dissolved, which means the end of the business.
• One partner might be removed or expelled from the partnership. This is a good option of the other partners are happy to continue with the business.
Whatever the circumstances, it is very important that there has been a partnership agreement drawn up to cover the potential situation of disputes between members.
Is mediation useful in resolving business partnership disputes?
For the right cases, mediation can be hugely beneficial. Mediation is particularly effective when trying to resolve situations as quickly and sensibly as possible. Bear in mind too that mediation has the additional bonus of being confidential. If however formal legal action is needed, we can act swiftly and decisively.
Can I just get rid of one of my business partners?
No. If there is no written agreement in place, you cannot expel a partner or member of a LLP, change the way profits are distributed or carry on with the partnership if one partner takes steps to dissolve it. A well-written partnership agreement will have rules set out regarding arbitration or mediation in case of dispute.
How are employment rights affected during a dispute?
It’s important to remember that sometimes partners or LLP members have employee status if they are paid a salary, and therefore have all of the rights of any other employee. Remember, therefore, that issues around discrimination or unfair dismissal could result in an employment tribunal, and the paying of substantial compensation.
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