Save yourself the money. Seven reasons why you may not need a Partnership Agreement
Spencer Laymond is a company lawyer with Curwens Solicitors. He sets out here his seven reasons why you may not need a partnership agreement and save yourself the money.
This may seem an unusual headline. Why would you not want or need a partnership agreement? After all, isn’t it common sense? If you are in business with someone, shouldn’t you have a written partnership agreement? Surely it would be bad practice not to have a partnership agreement, especially if cost was not an issue?
Well, without giving the game away early, yes, if you are in business with other people, then there really should be some agreement in place setting out the expectations and exit strategy. Yes, there will be a cash investment, in order to prepare a suitable partnership agreement but it can be dull reading explanations of things we know we should be doing, especially if it is the same old information, said the same old way. So we have turned this subject on its head, to make it a little more interesting and persuade a few more people, not only to take notice but also to take action.
We make one assumption – that you are in fact in partnership. So here they are – seven reasons why you may not think you need a partnership agreement…
Reason 1 – You and your business partners are immortal
If you and your business partners believe you will never die, will never suffer a serious accident or illness, or will never find yourselves incapable of continuing your role in the business (whether through age, mental capacity or otherwise), then, as much as you do not need an agreement to breathe, you may not need a partnership agreement regulating what to do if one of you should die.
If you want to check the law for yourself – the Partnership Act 1890, section 33(1) provides that a partnership is automatically dissolved on the death of any partner. That’s it. Without an agreement, on death of a partner, the business comes to an abrupt end.
But, if the death of a partner is not enough grief and aggravation, the business coming to an end itself sets a process in motion. When a partnership is dissolved, the dissolution means the start of a process of winding up. The process of winding up then disposes of the business, settling accounts with creditors and returning any surplus assets to the partners. At the end of the winding up, what once was the partnership business will be confined to history. Winding up can also give rise to unexpected and adverse legal and tax consequences.
So if you and your business partners are not immortal, the takeaway point is that there can be fatal consequences to the business, if there is no partnership agreement in place.
Reason 2 – It is reasonable for any one partner, at any time, to put the business into dissolution
Staying with the same doom and gloom theme of dissolution, if it’s perfectly reasonable for all the partners to walk around as if they have full and unrestricted access to a “button” which can be pressed at any time, a button which if pressed will kill the partnership immediately, irrespective of the circumstances and consequences to the business and other partners, then you may not need a partnership agreement.
If you want to check the law for yourself – Under the Partnership Act 1890, there are not one, but two sections that enable a partnership to be brought to an end by any partner at any time. These are sections 26(1) and 32(c). So, without an agreement, any partner, at any time, for any reason, can immediately trigger the dissolution of the partnership, and its winding up.
However, even if you and your partners have all the trust and confidence in the world in each other, even if you are family or lifelong friends, to protect the business, to provide some assurance in the event of a change in circumstances, a partnership agreement will be required.
Reason 3 – You and your business partners are happy to divide profits and losses equally, even if you have contributed different amounts of capital
Say, for example, you are in a three person partnership. Partner 1 has invested £10,000, partner 2 has invested £20,000 and partner 3 has invested £30,000. We are treating the investments as genuine capital contributions, in the sense that once the money has been invested in the partnership, it becomes permanently endowed to the partnership. The total capital invested is £60,000, of which partner 1 has invested 16.67%, partner 2 has invested 33.33% and partner 3 has invested 50%. Each partner does exactly the same work and contributes exactly the same amount of the time to the business. Each year the business makes profits of £100,000, and each year all partners are happy to share the profits equally so that each partner receives £33,333.33. Equally if each year the business makes losses of £100,000, then the partners are happy to share the losses equally. If all partners are happy for the profits and losses of the partnership to be shared evenly, then you may not need a partnership agreement.
If you want to check the law for yourself, it’s section 24(1) of the Partnership Act 1890. However, if you and your partners wish to share profits (or losses) in a way which reflects the original investments and perhaps different on-going contributions, then a partnership agreement will be required.
Keep in mind also that capital contributions may not be solely cash, but other property such as land and equipment. Whilst partnership accounts may make clear what assets are owned by the partnership and what assets are retained personally by an individual owner, there have been occasions where the courts have not accepted the evidence of the accounts – my third reason for a written agreement.
Reason 4 – It is reasonable for a majority of partners to oppress a minority of partners
Here we are concerned with the day to day management of the partnership business as well as its longer term direction. If you are a partner, you will automatically have a right to participate in the management. However, if you have no issue with your voice and opinion effectively falling on deaf ears and counting for nothing; if you have no issue with the seniors steering the ship as they please; if you have no issue with how decisions, big or small, are resolved, then you may not need a partnership agreement.
If you want to check the law for yourself – the Partnership Act 1890, section 24(5) provides that every partner is entitled to take part in the management of the business. Section 24 (8) then provides that differences on “ordinary matters” connected with the partnership business may be decided by a majority of partners.
The law being the law, the rules are subject to two exceptions, a few provisos and a qualification.
The exceptions: There are two matters where even a minority partner has a veto. First, changes to the nature of the business, for example, going from software development to fish farming. Second, whether to admit a new partner – but that is about the sum of it so far as the statutory veto rights go.
The provisos: All partners have a right to be heard; have a right to be notified of meetings; owe a duty of good faith to all partners; nevertheless, when it comes to voting, the minority can still be outvoted.
The qualification: The rule is the majority decide “ordinary matters“, but what may be regarded as an ordinary matter in one partnership, may not be regarded as an ordinary matter in another partnership. So it is not just the number of partners voting for or against a matter that may count, but what the matter itself relates to. Is it an ordinary matter or not?
The point to takeaway here is that the Partnership Act creates scant protection for partners who find they are being oppressed by the majority. If this is acceptable then a partnership agreement may not be required.
If certainty and fairness are important, then a partnership agreement will be required.
Reason 5 – It is reasonable for a partner leaving the business to (a) freely take with them existing partnership clients (b) work for a local competitor (c) poach existing partnership staff
If the loss of clients and customers, if the loss of staff and other partners, and if the expansion of a local competitor business at the expense of your own business is of no concern to the partnership, then you may not need a partnership agreement.
If you want to check the law for yourself, it will be a quick exercise. With the exception of a very few very limited and case specific examples, there is no law by default that provides any of these or other restrictions on partners. On the contrary, the law that there is on the subject, is law which provides for the framework as to whether any restrictions in an agreement are in fact enforceable, and whether restrictions are fair and reasonable to protect a legitimate business interest.
So if protecting your clients and customers, your staff and partners and if you do not want your competitors to get richer at your expense, are important, then a partnership agreement will be required.
Reason 6 – Even if a partner’s conduct is akin to gross misconduct, they are disqualified from their profession, they have committed murder, it is reasonable not to have a right to expel them
The principle of the partnership is “partners until death do us part”, so no matter what behaviour or scenario affects another partner, once in the partnership they have guaranteed membership for life, then you may not need a partnership agreement.
If you want to check the law for yourself – the Partnership Act 1890, section 25 provides that no majority of the partners can expel any partner unless power to do so has been conferred by express agreement between the partners.
If on the other hand you may be concerned with not having an effective remedy if a partner breaches an agreement, suffers prolonged mental or physical ill health, becomes insolvent, gets disqualified, ceases to hold relevant qualifications, neglects to perform his or her duties, is found guilty of a serious criminal activity or otherwise brings the partnership into disrepute, then a partnership agreement will be required.
Reason 7 – It is reasonable for one partner to take full responsibility for paying the debts and liabilities of a bankrupt partner
If your business partners all become bankrupt and the partnership has liabilities to pay, if those liabilities are either not covered by insurance or there is no insurance at all and you are happy to meet all the liabilities yourself, as your partners do not have the means, then you may not need a partnership agreement.
If you want to check the law for yourself – the Partnership Act 1890, section 9 provides that every partner in a firm is liable jointly with the other partners for all the debts and obligations of the firm.
Whilst there are some finer distinctions to this rule, the joint liability rule is a sound principle on a statutory footing. Furthermore, keep in mind another consequence of partnership is that all partners are jointly liable for (a) wrongful acts and omissions of the other partners – in other words all partners are jointly responsible for the negligence of another partner; and (b) the misapplication of property or money received from third parties by one partner – in other words all partners being jointly responsible for another partner “doing a bunk” with a client’s money.
So if you don’t fancy being the “fall guy” and having to risk losing your home and jeopardising the financial integrity of your family assets, then a partnership agreement will be required. Moreover, depending on the nature of the business and availability of insurance, it may even be necessary to incorporate your partnership into a limited liability partnership (LLP); the subject of which is a blog for another occasion.
In conclusion, you may not need a partnership agreement and you can save yourself the money in having one prepared, if (and only “IF”) :
- You and your business partners are immortal;
- It is reasonable for any one partner, at any time, to put the business into dissolution;
- You and your business partners are happy to divide profits and losses equally, even if you have contributed different amounts of capital;
- It is reasonable for a majority of partners to oppress the minority;
- It is reasonable for a partner leaving the business to (a) freely take with them existing partnership clients (b) work for local competitor (c) poach existing partnership staff;
- Even if a partner’s conduct is akin to gross misconduct, they are disqualified from their profession, they have committed murder, it is reasonable not to have a right to expel them; and
- It is reasonable for one partner to take full responsibility for paying the debts and liabilities of a bankrupt partner.
However, if none of the above applies to you and you are in a partnership, then you really should consider putting a partnership agreement in place.
If you have any questions relating to this blog then please contact Spencer Laymond, our company law specialist either by email at mailto: email@example.com or by telephone on (020) 8363 4444.