The consequences of not having a written Partnership Agreement
When partners initially go into business, they are motivated and happy to embark on an exciting new venture together.
They believe they will be in business together forever, or until they sell the business, assuming nothing will go wrong and often start trading without a written partnership agreement.
Partnership agreements can manage expectations, provide confidence about the future of the business venture and act as a safeguard to protect both the business venture and each partner’s investment.
So what happens when things go wrong and you don’t have a written partnership agreement?
Rebecca Robinson, director at Wake Smith Solicitors in Sheffield looks at the consequences.
“A partnership comes into being where persons are "carrying on in business in common with a view to profit".
“Since a partnership is automatically formed once the above definition is satisfied, it is not necessary for there to be a written partnership agreement and the provisions of the Partnership Act 1890 (Partnership Act) will be deemed to apply, often with unintended consequences.
“As is often the case, relationships with intending business partners start off well and the parties have the best of intentions of putting in place a partnership agreement.
“However, once the business is up and running the time pressures of running a business take over and the parties never formalise a partnership agreement.
“Relationships can sour and we are then asked to advise on the position. It is at this point that the parties are told that the archaic provisions of the Partnership Act apply in the absence of a written partnership agreement to the contrary.”
Below is a summary of some of the more important provisions implied by the Partnership Act:
Profits - in the absence of a specific provision to the contrary, section 24 of the Partnership Act provides that profits and losses are to be divided equally.
This can be problematic where, for instance, there is a part-time partner and it is intended that the part-time partner receives a pro-rata share of the profits or where there is a "sleeping partner" who has contributed more working capital for the partnership and as such may want to receive a higher profit share.
Dissolution and Retirement - section 26 of the Partnership Act provides that any partner can dissolve the entire partnership by notice to the other partners with immediate effect at any time.
The effect of dissolution is that the business stops trading, the partnership's assets must be realised, its liabilities must be paid and any surplus returned to the partners. Instead, it may be more appropriate for the business to include provisions for an orderly retirement of an individual partner by giving a reasonable length of notice to the other partners.
There can also be the option for the continuing partner(s) to buy out the outgoing partner's interest. There should then be detailed provisions of how to value the outgoing partner's share together with clauses dealing with the outgoing partner's and continuing partners' obligations to each other; for example, should an outgoing partner be subject to restrictive covenants not to compete with the partnership or approach customers for a given length of time?
Notice provisions also allow time for the remaining partners to raise the money to buy out the outgoing partner as well as giving time to contact clients and customers to preserve continuing business relationships.
Death - the Partnership Act provides that if any partner dies the entire partnership is dissolved and the partnership's assets must be realised and liabilities paid.
If this is not the intended result then there will need to be an express provision that, upon the death of any partner, the partnership continues as regards the remaining partners.
Expulsion - in the absence of an express provision to the contrary section 24 of the Partnership Act provides that the partners cannot expel a partner.
Often this is not ideal; if a partner commits a serious breach of duty, if a partner is convicted of a criminal offence or if a partner ceases to belong to a compulsory regulatory body, then the other partners may want to have the ability to remove the offending partner from the business.
The provisions of the Partnership Act are not particularly suited to modern day working practices. Wake Smith can offer advice on setting up businesses and the legal requirements.
For further advice please contact Rebecca Robinson at firstname.lastname@example.org or on 0114 224 2007.