The Importance of a Partnership Agreement:
A partnership is a business structure in which two or more individuals participate, in order to facilitate a common business ambition, with the desire to earn a profit.
This on the face of it seems an attractive solution due to its relative simplicity. There are no forms to complete and no mandatory registration requirements to fulfil.
The mere satisfaction of the definition within Section 1 of the Partnership Act 1890 (“PA 1890”) is all that is required to create a partnership:
“Partnership is the relation which subsists between persons carrying on a business in common with a view of profit”
Suppose we use the example of 3 partners, Bill, Ben and Andy, who have decided to set up a gardening business with a view of splitting profits equally. This arrangement would satisfy the definition of a partnership. The partners decide to not bother with a written partnership agreement to save costs. They’ve known each other for several years and they all get on well.
In the absence of a partnership agreement, the three partners are now bound by the requirements of PA 1890 by default.
Section 24 of the PA 1890 contains a number of implied provisions regarding the running of a partnership. However the act is over 120 years old and cannot be expected to meet all the modern day business expectations.
How could this affect Bill, Ben and Andy?
Here are some examples:
Share in Income Profits and Losses and Work Input
Let’s say for the first 6 months of the partnership, business is running smoothly. All the partners are equally contributing to the work and management of the partnership, and happily splitting the profits equally.
However after 6 months Andy has become erratic and is not turning up to help with jobs. It appears Andy has no credible reason to why he is not contributing to the work, and Bill and Ben are having to do most of the work themselves.
Absence of a written partnership agreement
The default position under the PA 1890 is that Andy is still entitled to receive an equal share of the profit even though he is contributing considerably less to the work load. This has caused understandable tension between the partners. Additionally, there is no obligation under the PA 1890 for either Bill, Ben or Andy to devote equal efforts to the business.
With a written partnership agreement
A written partnership agreement could have included details of the degree of commitment expected from the partners and a detailed basis for a division of profit, ensuring a contractual obligation on Bill, Ben and Andy to equally contribute to the work load as well as sharing equally in the profits. Or, they could have agreed different levels of time commitment, with a corresponding adjustment to the profit sharing arrangements.
A breach of this express provision by Andy would have been a breach of a contractual obligation of the partnership agreement.
Retirement
Retirement in the context of a partnership is not the same as the general word ‘retirement’ (being eligible to collect old age pension). Retirement simply means leaving the partnership. However the PA 1890 does not provide for retirement either.
Absence of a written partnership agreement
If Andy were to leave, this would trigger an automatic dissolution of the partnership and the business would have to be wound up. This means that any assets and liabilities would be shared equally between Bill, Ben and Andy. If Bill and Ben wanted to continue, they would have to form a new partnership. All of this would be time consuming, costly and disruptive to the running of the business.
With a written partnership agreement
A written partnership agreement could have included an express provision of what would happen when a partner wants to leave, without dissolving the partnership, including appropriate terms for the payment of Andy’s share in the business.
How can we assist?
Problems can arise in any business. The potential for damaging consequences can be significantly reduced by taking advice from the outset and ensuring that all the partners understand what they are signing up to.
There are many more factors that may be included in a written partnership agreement that the PA 1890 does not cater for, such as expulsion, financial input, drawings, ownership of assets and restraint of trade.
Hatchers Solicitors have extensive experience and provide a comprehensive legal service to our strong client base of local, national and international businesses.
If you need specialist advice then please contact the Business Law Team on 01743 237693 or email mail@hatchers.co.uk.
