Partnership Agreements Law & Practicalities
23 Jul 2021
A partnership agreement is crucial to protect yourself in the eyes of the law and set clear rules straight from the start of a business partnership, helping you to avoid costly legal issues and unnecessary conflict. By creating a formal, detailed partnership agreement, you can record each partner’s rights and responsibilities.
What is a partnership agreement?
A business partnership is when two or more people run a business together to make a profit. It is a different type of business to a limited company, which is run by shareholders. Within that environment, a partnership agreement is a legally binding agreement between all business partners. This document’s purpose is to provide a written contract of all relevant rules and regulations on how the respected partners will run the business.
A partnership agreement should be drawn up prior entering a business partnership, however it can also be written for existing unions. Additionally, the contract can be written or unwritten. We advise opting for a written document because it provides evidence of the agreement and can be referred back to in case of a dispute between partners.
Why you might need a partnership agreement
A partnership agreement is a voluntary agreement as it is not required by law. However, we recommend drawing up one because without a written agreement, your partnership will be controlled by the Partnership Act 1890.
Essentially, this act sees all partners as equals, which has many downsides, including potential financial loss, legal liability as well as an unclear and complicated way to exit the partnership, as discussed in more detail below.
Even if you have a partnership agreement in place, it is a good idea to review the points below to see if the agreement needs updating, as an old agreement can cause just as many problems as one that’s missing altogether.
Legal liability and costs
According to the Partnership Act 1890, all legal and financial liabilities must be shared to the same degree between all parties. However, your agreement can dictate whether all parties are equally liable for the legal and financial consequences of other partners’ business decisions and therefore overrule the default rules. Without a partnership agreement, you are essentially putting your assets and liabilities in the hands of others. A partnership agreement allows each partner to bear the responsibility for their own decisions.
Finances: capital contributions, profits and losses
The document can record each partner’s capital contribution as well as a procedure to follow if additional capital is needed. If you don’t have a partnership agreement, according to the Partnership Act 1890, all partners have to contribute an equal share of the capital and distribute the profits and losses evenly.
Alternatively, you can draw up a partnership agreement that fits your unique business needs.
For instance, your contract can determine the process and degrees of how you and your partners share profits or cover losses, which overrides the equal share rule from the Partnership Act 1890.
A clear blueprint of how you and your partners will run the business
Similarly to the previous sections, in line with the Partnership Act 1890, all partners are expected to contribute an equal amount of time to the business and, correspondingly, have an equal say in all business decisions.
Instead of spending crucial business time on unnecessary meetings and disputes, your agreement can outline each partner’s responsibilities and powers in running the company, thereby distributing duties in the most efficient way and ultimately future proofing your venture.
Another key aspect to include in your agreement is the plan of action for handling day to day responsibilities. It is essential to divide roles and set expectations as early as possible to avoid misunderstandings and disappointment over the long term.
Terminating the partnership
When starting a new business, the eventual end of the partnership is unlikely to be at the forefront of your thinking. However, from our experience it is advisable to have a detailed plan in place for scenarios such as voluntary retirement, or the expulsion or passing of a partner.
Without a partnership agreement, you are taking the risk of ending the partnership at any given time by simply one the partners handing in their notice. By default, the passing of a partner implies the end of the union unless stated otherwise in the partnership agreement.
Our solicitors can guide you through preparing your bespoke partnership agreement with specific exit clauses.
A partnership agreement should include…
Based on the potential liabilities discussed in the previous sections we recommend including the following rules and policies in your partnership agreement. The agreement is legally binding, so make sure to craft a bespoke agreement and have all partners sign it.
A partnership agreement checklist
- Information about the partners and business
- Individual capital contributions
- How you will share profits and offset losses
- Conflict policy
- Voting powers and decision making
- Confidentiality policy
- Exiting or joining the partnership
- Structure: roles and duties
- Legal and financial liability
- Handling day to day operations
- Dissolution policy
Do I need a partnership agreement to work with someone I’m close to?
A partnership agreement is a good idea even if the person you’re working with is your spouse, family member or close friend. An agreement not only protects partners in case something goes wrong, it also provides a framework for day to day running of the business and, as such, can be a helpful document to think through at the start of your venture.
What can happen without a partnership agreement?
Having encountered a number of these cases in my career, I’ve seen examples of when a lack of a partnership has caused serious problems during business closure or through periods of change.
Partnership assets caused a problem for an indie band
A well-known indie rock band split up after a successful few years. There was no written partnership agreement. Two of the members of the band wanted to continue separately, in their own right, but use the assets of the Partnership, namely the name of the group and the backing tracks.
The matter ended up in the High Court where the court declared the assets to be Partnership Assets. A well thought out partnership agreement would have anticipated such issues and catered for them.
As it turned out, the case spiralled downwards into a vitriolic war with application and cross-application leading to six figure costs for both sides and an outcome neither party was happy with.
Two brothers were unable to agree a way move forward with their family farm
A large Lakeland farm was inherited by two sons on their father’s death. The sons who had been running the farm continued with it as they had for generations before, but then they fell out and there was no partnership agreement dealing with such disputes and exit provisions.
Both wanted the farm. It was not possible to split the farm as the parts of it were co-dependent on the other and it was not commercially viable without the other parts. Ultimately, the farm had to be sold, leading to the loss by that family of the land and way of life they had enjoyed for generations.
How can Richard Nelson LLP help you with a partnership agreement?
Partnership agreements can be tailored to suit any partnership arrangement, but a partnership is not always the most suitable way to run a business. If you are still planning your business, you can also explore other options, such as starting a limited company, an LLP (limited liability partnership) or operating as a sole trader. In these instances there will be other legal processes to follow, but a partnership agreement won’t be needed.
If you have decided to operate as a business partnership, we recommend drafting a partnership agreement. Our commercial solicitors can guide you through the process, advise on the specific type of a partnership agreement you should choose, draft a complete document or review your existing documents and drafts. Get in touch to see how we can help you with your bespoke partnership agreement.