Legal 101

What is a Partnership?

Amber AkhtarAmber Akhtar
Last updated on:
May 11, 2022
Published on:
May 11, 2022

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A Partnership is the relation which subsists between persons, carrying on a business in common with a view of profit, as defined by s1 of the Partnership Act 1890 (PA 1890). A partnership is created once this definition has been satisfied.

What is a business?

As per s45 PA 1890, a business includes “every trade, occupation or profession”, virtually any activity of a commercial nature is capable of giving rise to a partnership. However it must be more than a mere agreement (Illot v Williams & Others [2013] EWCA Civ 645).

There is no requirement for the parties to have actually commenced trading as there is no rule of law that the parties to a joint venture do not become partners until trading commences. The rule is that individuals who agree to carry on a business activity as a joint venture do not become partners until they actually embark on the activity in question, in Khan v Miah [2000] 1 WLR 2123 a partnership was held to exist where the parties had agreed to open a restaurant together and taken steps pursuant to this, including opening a joint bank account, obtaining a bank loan and acquiring premises, furniture and equipment.

When is a business in Common?

For it to be in common, there must be at least two or more people who share responsibility for the business and for decisions which affect the business. This is in contrast with an employer/employee relationship where the employee must accept the decisions and instructions of the employer. A partnership can also be formed by two or more companies.

When is there a view of Profit?

The purpose or view of the business must be to make money, as such charitable motives are unable to constitute partnerships.

What characteristics might be indicative of a Partnership?

The main characteristics which might indicate a partnership are:

  • Being involved in making decisions which affect the business (s24(5));
  • Sharing the profits of the business (s24(1));
  • Examining the accounts of the business;
  • Insisting on openness and honesty from fellow partners;
  • Being able to veto the introduction of a new partner (s24(7)); and
  • Sharing responsibility for losses made by the business (s24(1)).

Decision Making

Partners are able to make decisions by passing a majority vote. However, a decision to change the nature of the partnership business can only be made unanimously (s24(8)) and new partners can only be introduced with the consent of all existing partners (s24(7)).

What are a Partner's Responsibilities?

Partners are required to maintain a duty of the utmost fairness and good faith to one another, s28-s30 expands on this duty:

  • s28: Partners must divulge all relevant information connected with the business and their relationship to the other partners (for example, if, when selling business premises to the partnership, a partner suppresses information about the value of the premises.
  • s29: Partners must account to the firm for any benefit derived without the consent of the other partners from a transaction concerning the partnership.
  • Has the partner derived a benefit? Was this with the other partners’ consent? For example, if a partner is asked by a client of the firm to do some work in his spare time, the money received from this will be cash of the partnership unless the other partners consent to him keeping it.
  • s30: If a partner runs a business “of the same nature” and competes with the firm, he must account for any profits made by this unless he has the consent of the other partners.
  • This catches businesses in direct competition with the partnership. This does not necessarily include similar, but non-competing businesses e.g. businesses in a different part of the supply chain.

What should be included in a Partnership Agreement?

The Partnership Act 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.

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What are the areas of Importance of a Partnership Agreement?

Commencement Date

  • 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 insecure 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.

Sharing of Profits/Losses

  • 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.
  • 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.

Drawings

  • 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.

Work Input

  • 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.

Retirement

  • 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.

Expulsion

  • 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 Partner’s 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.

Non-compete Clause

  • 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.

Arbitration

  • 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.

Liability for Partnership Debts

Who can the Firm’s debts be enforceable against?

  1. The Partner who made the contract can always be sued as there will be privity of contract between the partner and the other party.
  2. The Firm will be liable if the contracting partner had actual or ostensible authority. If the Firm is found to be liable, the creditor can sue the firm as a whole, or any person who was a partner at the time the debt was incurred can be sued individually. Under s9 of the Act, the Partners are “liable jointly with the other partners… for all debts and obligations incurred while he is a partner” - partners are jointly and severally liable.

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