The Partnership Act 1890 (PA 1890) implies terms into every partnership agreement. These terms are not always appropriate for every partnership business and the terms are not always comprehensive in what they cover and so a written agreement may be necessary.
The partnership agreement should include the responsibilities of each partner, how profits and losses are distributed, the decision making process between the partners, whether they will be entering into a general partnership agreement or a limited liability partnership, the introduction of new partners, what happens in the event a partner leaves or the partner dies alongside other important terms as stipulated by the PA 1890. This article unfolds a number of provisions of the PA 1890 with regards to the partnership agreement.
- The partnership comes into being when s1 of the Partnership Act definition is satisfied.
- It is desirable to include a clause which specifies the start date of the partnership so it is certain when the rights and obligations arise
Duration and Dissolution
- The Act does not prescribe a duration instead s26 of the Act states if there is no agreement to the contrary, the partnership will be a partnership at will. Which means the partnership continues unless a partner gives notice to terminate the partnership.
- This may be problematic if any partner is able to terminate the entire partnership at any time by giving notice of his intentions to do so to all the other partners, as per s26. In addition notice is immediate and does not need to be in writing unless the partnership agreement is made by deed (s26(2)). This could be a flexible option for partners, but it is an unsecure option for the business as the whole partnership can be brought to an end based on the decision of a single partner. Partners may wish to make amendments and specify a minimum period of notice, agree a fixed term (continuing thereafter with a minimum notice period) and that the partnership shall continue as long as there are two surviving partners.
Dissolution under s33 PA 1890
- The Act states that the death or bankruptcy of a partner will automatically dissolve the partnership.
- It may be useful to depart from this in the written agreement and provide that the remaining partners will automatically continue in partnership on buying out the deceased/bankrupt partner’s share.
Sale of Capital Assets and Sharing of Capital Increases
- As per s24(1) of the Act, Partners share equally in the capital of the business, increases/decreases in the value of assets are therefore also shared equally.
- Partners may want to deviate from this to reflect the capital contribution of each partner to the business. For example, if Partner A provides a factory worth £50,000 and partner B puts in £10,000 cash, under the Act if the factory increases in value to £60,000, the £10,000 increase would be split 50/50. Similarly if the factory is sold, Partner A will only receive £30,000 despite contributing an asset worth £50,000. It may be useful to specify in the agreement what assets are “Partnership Assets” in which all partners will have a beneficial interest and which assets belong to individual partners to prevent disputes.
Profit and Loss Distribution
- Profits/losses of the business are expected to be shared by the partners equally in accordance with s24(1), and s24(6) explicitly prohibits partners from receiving a salary unless an agreement to the contrary excludes this. As such partners are jointly liable and the default position is partners must divide profits and receive an equal share of the profits.
- Partners may wish to deviate from this to reflect the contribution of each partner to the business e.g. in terms of time/experience/capital contribution. For example:
- Paying on a salary bases;
- Specifying the partners are allowed interest in proportion to their capital contributions; or
- That profits/losses be shared in specific percentages as opposed to equally.
- The Act makes no mention of drawings.
- It may be desirable to place a monthly limit on how much each partner can draw from the business to prevent a partner draining funds.
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- As per s24(5) partners have a right but not an obligation to take part in the management of the business.
- As such, it is permissible to have a “sleeping partner” and partners may want to specify each partner’s obligations and avoid situations where a partner does nothing but is entitled to equal profits. For example a clause may be included to state a partner must devote his whole time and attention to the business or specify a number of hours per week etc.
- The Act does not mention retirement, partners have no right to retire under the Act however, partners can vary the partnership agreement by unanimous consent.
- It is useful to provide a clause which enables a partner to retire without unanimous agreement.
- The Act does not mention expulsion and does not provide for the possibility of a partner to be expelled by the other partners without his/her consent.
- It may be useful to provide a clause which enables the partners to expel a partner in prescribed circumstances.
Outgoing Partners Share
- In accordance with s42 of the Act, if the partnership continues but there is a delay in payment of an outgoing partner’s share, that partner/his estate will be entitled to:
- 5% interest on his share; or
- Such profits as are attributable to his share.
- When a partner leaves the business, the remaining partners will need to pay for his share or this could be sold to an external third party.
- It is useful to have a clause agreed from the outset, for example:
- Whether the partners have an obligation or an option to purchase the outgoing partner’s share’;
- The oasis on which the share will be valued and how to resolve disputes as to the valuation (e.g. professional valuation);
- The date on which the payment will be due;
- Indemnity for liabilities of the firm’ and
- Valuation of goodwill.
- Nothing in the Act prevents partners from setting up in competition on leaving the partnership.
- Where the firm continues, it is important to provide a clause which limits the outgoing partner’s freedom to compete.
- Such clauses must not be unreasonably broad or they will be void, the clause must:
- Protect a legitimate interest, for example the firm’s business connections, employees or confidential information;
- Be reasonable to protect that interest, for example it should be limited in its geographical scope and duration.
- Consider less burdensome clauses which do not restrict trade as a whole, as these are less likely to be unreasonable, for example:
- Non-dealing clause which prevents the partners from entering into contracts with customers;
- Non-solicitation clause which prevents the partner from soliciting contracts.
- The Act does not mention arbitration
- It can be useful to include an arbitration clause to resolve disputes and avoid publicity, delay and costly litigation.
In conclusion, it is important for individuals to consider entering into a partnership agreement when entering into a business partnership or other form of partnership. Individuals may choose to enter into a formal partnership agreement which stipulates the rights and obligations of each party under a written partnership agreement as specified by the PA 1890.