2 - Partnerships

Define partnership

A partnership is an unincorporated business and is not a seperate legal entitiy from its partners.

Partnership existts where two or more persons agree that they will run a business together, and actually do so. The existence of a partnership is very much a question of fact. The agreement to operate in partnership can be oral or in writing, or may even be implied by conduct. There is therefore no legal requirement for, although there are several advantages in, drawing up a partnership agreement.

Define partnership agreement.

Partnership agreement is a formal document setting out the terms of a partnership. It usually deals with the relationship between the partners and their relationships with third parties. It will often vary or amend key default provisions under the Partnership Act 1890 (PA).

Who can be a partner?

Generally, any legally capable person may enter into a partnership. Companies, as well as individuals, may be partners with other companies/individuals.

What is the maximum number of partners?

The maximum number of persons who may be members of a partnership used to be 20. However, certain professions (including solicitors and accountants) were exempt from this limit. Since 2002, no limits apply in any circumstances.

What is the law relating to naming the partnership?

The law relating to business names is contained in Part 41 of the Companies Act 2006 (CA). No restrictions will apply if the partnership name consists of only the surnames of all partners, with or without forenames or initials. In any other case, the CA will apply and certain words or expresssions forming part of the business name will require prior approval. These include words and expressions contained in the Company, Limited Liability Partnership and Business Names (Sensitive Words and Expressions) Regulations 2014.

Any partnership that uses a business name must also comply with the prescribed disclousre requirements under the CA (ss. 1200-1206). Generally, details about the partner must about the partners must appear at the main place of business and on partnership stationery.

What is the purpose of a written partnership agreement?

A formal partnership agreement is not a strict requirement, but it does have clear benefits, such as:

• it provides evidence of the partners’ relations and of the partnership’s terms

• it orverrides some of the provisions of the PA, which will automatically apply, except to the extenet that there is contrary agreement. Many of these ‘default provisions’ may have undesirable consequences for modern partnerships.

What are the default clauses in partnership agreements - the parties?

The parties: the parties to the agreement will be the partners. No new partners may be admitted without the consent of all the partners (s 24(7) PA). Although sensible for smaller partnerships, this may be unworkable for large ones.

What are the default clauses in partnership agreements – commencement date?

Commencement date: remember that the existence of a partnership is a question of fact; the partnership will exist from the date the s 1 PA criteria are satisfied. Therefore, an agreement subsequent to that date will only govern rights and responsibilities from that date.

What are the default clauses in partnership agreements – nature and place of business?

Nature and place of business: the nature of the business is important to the question of a partner’s authorirty and the extent to whcih a partner may bind the partnership. Unanimity is required by the partners in order to change the nature of the business (s 24(8) PA). It is usual to specficy the place(s) at which the business will be carried out.

What are the default clauses in partnership agreements – partnership name?

Partnership name: no restrictions will apply if the partnership name consists only of the surnames of all partnes, with or without forenames or initials. In any other case, the CA will apply and certain words or expressions forming part of the business name will require prior approval. These include words and expressions contained in the Company, Limited Liability Partnership and Business Names (Sensitive Words and Expressions) Regulations 2014.

What are the default clauses in partnership agreements – duration?

Duration: a partnership may run for a specific venture or a fixed term. A fixed-term partnership that continues after expiry will be presumed to continue on terms that are consistent with a partnership at will s 27(1) PA), otherwise it will be dissolved (s 32 PA).

What are the default clauses in partnership agreements – partnership at will?

Partnership at will: a partnership where no specific duration or fixed term is set. It is the most common type of partnership. With any partnership at will, the following will apply:

• any partner may determine the partnership (ie. bring it to an end) at any time on giving notice to the other partners. There is no requirement for written notice, unless the partnership agreement was made by deed (s 26(1) PA).

• the partnership shall be dissolved from the date specified in the notice, or if none is specified, the date of communication of the notice (s 32 PA).

Therefore, there is potential for the dissolution to be immediate and this can have serious consequences for the business. This would be a technical dissolution and the remaining partners may seek to continue in what would be a ‘new’ business. 

Accordingly, it is usual to provide in the agreement that the partnership will continue despite the retirement, death, expulsion or bankruptcy of a partner. 

What are the default clauses in partnership agreements – capital?

It is important to specify what each partner is contributing to the business and how capital profits/losses will be shared between the partners. In the absence of express or implied agreement to the contrary, the PA provides that capital profits and losses will be shared equally (s 24(1)). Although it may be implied that unequal contributions of capital result in the right to make unequal withdrawals of capital, a formal written partnership agreement should make this clear.

The agreement may also provide for interest to be paid on partners’ capital contributions. There is no right to interest on capital under the PA (s 24(4)), but this may be important, particularly where large capital contributions have been made. Provision should also be made for how future capital contributions will be made.

What are the default clauses in partnership agreements – income?

The agreement should specify how the income profits/losses of the business will be shared between the partners. In the absence of express or implied agreement to the contrary, income profits and losses will be shared equally (s 24(1) PA) and this may not be suitable to clients’ specific circumstances.

The agreement should also deal with the payment of salaries from profits before the final profit shares are divided. The PA does not provide for salaries to be paid to partners (s 24(6)) and this could be particularly important where, for example, not all partners work full-time for the business.

The final key point here is drawings (the amounts that partners withdraw on account of profits). A well-drafted agreement should deal with how and when drawings are made and provide for repayment (with interest) if too much is taken.

What are the default clauses in partnership agreements – partnership property?

The assets belonging to the firm should be specified, so they are clearly distinguishable from those assets that belong to the individual partners. For example, a freehold or leasehold property may remain owned by one individual partner but be used for the purposes of the business. A failure to deal with this properly can lead to disputes on dissolution and problems with taxation.

What are the default clauses in partnership agreements – management?

All partners are entitled to tkae part in the management of the business (s 24(5) PA). This may not be what is desired between the partners. For example, one partner may wish to take the role of a ‘sleeping partner’ and simply invest in the business.

All matters connected with the partnership business may be decided by a majority of the partners (s 24(8) PA). This is except for changing the nature of the business, where unanimity is required.

Thought should be given to whether unanimity should be required for other decisions and whether a majority decision should always be applicable. For example, the partners may wish for certain issues to be decided upon by the senior partners only.

Authority of the partners to bind the partners is also significant.

Absences should also be catered for (e.g. leave and illness).

What are the default clauses in partnership agreements – retirement?

Retirement, in this context, simply means leaving the partnership. The PA does not provide for the possibility of a partner leaving a partnership without the partnership being dissolved. This is a significant shortcoming of the PA and can have serious consequences for the continuing partners.

The agreement should include a mechanism for a partner to leave, following appropriate notice, and get what is owing to them, without dissolving the firm.

What are the default clauses in partnership agreements – death and bankruptcy?

Unless otherwise agreed by the partners, a partnership will be dissolved by the death or bankruptcy of any partner (s 33(1) PA). Again, this can have serious consequences for the continuing partners.

Provision should be made in the agreement for the continuation of the firm by the surviving/solvent partners and for the payment of the deceased/bankrupt partner’s share.

What are the default clauses in partnership agreements – expulsion?

Under the PA, no majority may expel any partner (s 25 PA). Therefore, an express power to expel a ‘problem’ partner should be included in the agreement, specifying the grounds for expulsion and providing for payment of the expelled partner’s share in the partnership. There should also be provision that the partnership should continue as regards the remaining partners.

What are the default clauses in partnership agreements – payment for outgoing partner’s share?

Specific provision should be made for the following:

• the remaining partners to have the option to purchase the outgoing partner’s share

• valuation of the outgoing partner’s share (e.g. preparation of partnership accounts, agreement on value, or independent determination, if agreement cannot be reached)

• payment of the outgoing partner’s share (e.g. payment by instalments or in a lump sum)

• dissolution, if the option to purchase is not exercised

On a full dissolution, the winding up will take place in accordance with the provisions of the partnership agreement, or s 44 of the PA.

Under s 44, the proceeds of sale are used to:

• repay third party creditors

• repay partner creditors

• repay partners’ capital entitlements

Any balance is then divided between the partners in accordance with their profit-sharing ratios.

Partnership losses are met from:

• income profits

• capital

• contributons made by the partners in the same proportion as their profit-sharing ratios

There may be financial advantage in selling the business as a going concern (ie a business that is still running), rather than dissolving the business. This is because there may be value in the goodwill of the business (ie the fact the business is already established, with a sound reputation and with a pre-existing client/customer base and business connections).

What are the default clauses in partnership agreements – restrictive covenants?

Consideration should be given as to whether there should be a restriction on ex-partners competing with the partnership business, approaching employees or former clients or dealing with former clients. No such covenants will be implied by the general law or through the PA, so specific provision will need to be made,

Careful drafting of any covenant is required if it so to be enforceable. The goodwill of the business is a valuable and legitimate interest to protect and the clause must be of reasonable in scope (eg in terms of duration and area). The more limited/reasonable the clause, the more likely it will be upheld.

Need to advise on whether a restraint of tade clause/restrictive covenenat is likely to be reasonable. For example, a clause restricting involvement with the same type of business as the partnership in the same geographical area for a year is more likely to be successful than one restricting involvement in the same type of business, across a much wider are and/or for a longer period.

What are the default clauses in partnership agreements – administrative provisions?

The partnership agreement will also need to contain sufficient administrative provisions to make it workable. For example, definitions and interpretation, service of notices, costs and arbitration in the event of disputes.

What are partners’ duties to each other?

Partners owe each other a duty of good faith and the PA provides for three fiduciary duties (ie. duties of trust and confidence):

• duty to provide true accounts and full information on partnership matters (s 28 PA)

• duty to account for profits dervied from the position as partner (s 29 PA)

• duty to account for profits from a competing business (s 30 PA).

Many partnership agreement will contain further provisions, for example that the partners are to devotre their whole time and attention to the partnership and are not to start or join any other business whilst they are a partner.

Further provisionsof the PA relate to the relationship bwteeen partners. In the usual way, these can be varied by contrary agrement. These include the right to inspect partnership books (s 24(9)) and the payment of 5% interest on loans made by the partners (s 24(3)).

Is the partnership liable to third parties?

The starting point for determining whether a partnership is liable is s 5 of the PA, which is based on the law of agency. Section 5 provides that each partner is an agent of their fellow partners and, as such, a partner acting within the scope of their actual authority or apparent/ostensible authority will bind the partnership as a whole.

Define actual authority

Actual authority: the partner is actually authorised to bind the partnership in the circumstances, whether under any partnership agreement or through authority given outside of one (specifically, generally or through a course of conduct).

Define apparent authority

Apparent/ostensible authority: it would appear to the third party that the transaction is authorised by the partnership in the circumstances.

Apparent authority asks fourt questions:

• Is the transaction related to the partnership business?

• Would a partner usually be expected to have authority to enter into the transaction?

• Does the third party know that the partner has no actual authority?

• Does the third party know that the ‘partner’ concerned is not, in fact, a partner of the firm or do they have susipicions that this is the case?

If a partner has entered into a transaction with either actual or apparent authority, then the partnership will be bound by that act.

If a partner has entered into a transaction with neither actual nor apparent authority, then the partnership will not be bound by that act and only the partner concerned will be fully liable.

If a partner has entered into a transaction with only apparent authority, he will liable to his fellow partners for breach of warranty of authority. In other words, the partnership will still be bound and the third party contract will not affected. However, the individual partner will be liable personally, to account to his fellow partners for any loss ot the partnership as a result of acting outside of the scope of what he was actually authorised to do.

It is imporant to distinguish between the relationship between the parrtners themselves and their relationship with third parties. A partnership agreement will often include provisions limiting any given partner’s activities (for example, purchases of over £5k require the consent of all the partners). However, the partner(s) will not be able to rely on these limitations as against a third party, unless that third party knew of them.

Which partners are liable?

Once it has been established whether the partnership as a whole is bound by a transaction with a third party, it must then be established precisely which partners are liable.

Partners are jointly and severally liable for the debts and obligations of the partnership without limit (s 9 PA). Where a partnership is unable to pay its debts out of partnership assets, a creditor is entitled to obtain payment from the private asset of the partners.

As a partner is jointly and severally liable for the firm’s debts, they can be sued for the full amount. If sued for the full amount, they would be entitled to an indemnity from the other partner for their proper share of the debt.

Which partners are liable - change of partners?

Following a change in the composition of a partnership, it is crucial to distinguish between existing debts (those incurred prior to the change) and future debts (those incurred after the change).

• A partner is liable for the debts incurred whilst they are a partner (s 9 PA)

• A new partner is not liable for debts incurred by the partnership beofre they became a partner (s 17(1) PA)

• A retiring partner is not released from debts incurred by the partnership whilst they were a partner (s 17(2) PA)

How can retiring partners protect themselves?

A retiring partner may seek to protect themselves from liability for existing debts through a deed of release, a novation agreement, or an indemnity.

Deed of release from willing creditors: a release of the outgoing partner from any oustanding debt/liability. Its effect is the release of outgoing partner.

Novation agreement from willing creditors: a tripartitie arrrangement between (1) the creditor (2) the partnership as constituted before the retirement (3) the partnership as constituted following the retirement. Consideration or a deed will be required for it to be valid/binding. Its effect is the newly constituted partnership stands in the shoes of the old one as regards the debt/liability.

Indemnity from the continuing partners: a tripartite agreement between (1) the outgoing partner and (2) the continuing partners. The effect is that it is not binding on third parties. The outgoing partner will still be liable but will be able to seek indemnity from the continuing partners.

What notice must retired partners give?

A retired partner may be liable for debts incurred after their retirement (ie future debts) if they fail to comply with sections 36 and 14 of the PA.

Section 36 of the PA says that a retiring partner must give notice to third parties of their leaving the partnership. This is because people who deal or who have dealt with the firm are entitled to assume that there has been no change in composition of the partnership unless they have notice of it.

There are two types of notice under s 36 actual and constructive.

• Actual: 36(1) PA. Notice to existing/former clients/customers by informing them directly (eg send out standard letters).

• Constructive: 36(2) PA. Notice to potential/future clients/customers by placing advertisement in the London Gazette (for partnerships in England and Wales).

What is holding out?

A retiring partner must also avoid being held out as a partner under s 14 of the PA.

Holding out involves:

• doing something or allowing something to be done or represented that suggests one is a partner

• which is relied upon by someone

• who gives credit to the firm as a result

If holding out, partner may still be liable under future contracts as these representations are likely to have been relied upon in the course of business.

What is the approach for ascertaining partnership liability for debts?

1. Is the partnership liable - actual or apparent/ostensible authority

2. Which partners are liable - section 9 and 17 PA

3. Liability for existing debts - release/novation/indemnity

4. Liability for future debts - sections 36 and 14 PA