Partnerships
A legal FAQ from Roger Sinclair
This FAQ is about Partnership, under the law
of England & Wales. A word of caution - this FAQ cannot hope to do more than
give a sketchy introduction to what Partnership means, and in no way may it be
considered to be a comprehensive statement of the law.
The governing law is principally the
Partnership Act 1890.
Partnership is defined as 'the relation
which subsists between persons carrying on a business in common with a view of
profit'.
Its key features are:
- 2 or more partners
- sharing of profits (not
turnover; not expenses; but profits)
- there may be a
Partnership as a matter of law, with all the consequences that entails, even
though the parties may not want one, and even if they expressly say there
isn't one!
What
does the Partnership Act 1890 provide?
Basically three things.
- As between themselves,
partners are free to decide who does what, who contributes what, who takes
what
- But if they don't so
decide, the Act implies various defaults - eg equal sharing of profits &
losses, equal contributions to capital, equal responsibilities to work
- As between the
partnership & the rest of the world - in most situations, the Act provides
that all the partners are answerable for the acts and defaults of any one of
them in connection with the partnership business; and there is joint and
several liability for partnership debts - meaning that the creditor can pick &
choose which partner(s) he goes for.
As stated above, Section 1 of the
Partnership Act defines a partnership as being 'the relationship which
subsists between persons carrying on a business in common with a view of profit'.
Business is widely defined as being 'every trade, occupation or profession'.
Under English law a partnership is not a separate legal entity, and the question
of whether a partnership exists in law can only be answered by considering all
the circumstances in the light of the statutory definition - ie regardless of
whether the parties say it is, or is not, a partnership.
An agreement which contains eg 'this is a
partnership' suggests that there is a partnership but is NOT conclusive evidence
of this.
On the other hand, an agreement which
contains eg 'this is not a partnership' suggests that there is not a partnership
but is NOT conclusive evidence of this.
Whether or not there is a partnership is a
matter of law, and not just of what the parties say or intend.
If two or more persons or companies trade on
the basis that they share profits - ie net receipts, as opposed to gross
turnover - then whether they like it or not, and whether they expect it or not,
it is likely that they will be treated as if they were partners, with all the
legal consequences of that.
Some of those legal consequences are capable
of being changed by express agreement between the parties - such as:
- the right of each
partner to an equal voice in management
- equal sharing of
capital profits and losses
- equal sharing of
revenue profits and losses
- equal liability to
contribute to the partnership's capital needs
- whether either party
may buy the partnership assets on dissolution
Some of the legal consequences however
cannot be changed:
- either partner can
commit the partnership in a legal obligation or liability to a third party
- partners are jointly
and severally liable to third parties for all partnership debts and
liabilities
- the partnership does
not have a legal persona separate to that of the participants
- partners cannot make a
'secret profit' out of their dealings with the partnership, but have to
account to the partnership for any profits they make
- the partnership will be
dissolved if either partner goes into liquidation or becomes insolvent
- tax assessments are
made on the partnership for profits. If the partnership fails to pay the
revenue can look to any partner for payment of the whole amount of tax
The potential consequences of these aspects
which cannot be changed are where the dangers lie. You are wholly at risk,
without limit as to amount, from commitments and liabilities to third parties
which may be incurred by the other partner, even without your knowledge, and
even if incurred in breach of your partner's obligations to you. [The point is
that the outside world, eg a lender, does not know the content of the
partnership agreement. If he did know though, ie if the
lender knew that taking out the loan in the name of the firm was outside
that partner's authority, then the loan would not be binding on the
partnership - it's up to the partnership to place the lender 'on notice' about
that.]
And if, for example, the Partnership were to
succeed but the other party fell into financial difficulties or went bankrupt
(or, if a company, into liquidation), this would put an end to the Partnership
even though it was succeeding. You could then find the Inland Revenue and other
creditors coming to you personally for payment of liabilities relating to
the Partnership - without limit as to amount, and regardless of the value of
your stake in it.
Partnership therefore requires a very high
degree of trust between partners - even greater than you would require to give
sole signing rights to someone else over your bank account.
However, so long as the risks are clearly
understood, a Partnership can have advantages. A Partnership is quick and easy
to set up, and internal arrangements are flexible enough to be able to be
structured as the parties require.
If Partnership is chosen, it is essential
for a proper partnership agreement to be prepared, which clearly defines the
position and responsibilities of each party.
Some
key differences between Partnership & a Limited
Company?
- A Limited Company is an
independent legal 'person' in its own right. A partnership is not.
- Liability for debts.
In a Partnership, all partners are jointly & severally liable for all
partnership debts, to the full extent of their assets. This includes eg a
partner's liability for tax on his share of the partnership profits - this is
payable by the partnership, so all the partners are liable for it.
In a limited company on the other hand, the shareholders are only liable for
company debts to the extent of any unpaid sums due on their shares. Directors
are not liable for the company's debts so long as they run the company
lawfully (unless of course they have made themselves liable by giving personal
guarantees).
- Taxation
A partnership is liable for tax under Schedule D. Expenses 'wholly &
necessarily incurred' for the purposes of the trade are deductible.
A Limited company is liable for Corporation tax, & its prime movers would
generally be its directors & would get their money out as salary - taxable
under Schedule E - only expenses which are 'wholly necessarily & exclusively
incurred' for the purposes of the trade are deductible - this is considerably
more restrictive, and there is less flexibility for claiming expenses without
paying tax on them.
- National Insurance
Partners are self-employed under National Insurance law, and liable to pay
contributions under Class 2 and Class 4.
Directors and employees of a limited company are classed as employed, and
liable for Class 1 National Insurance contributions.
- Administration cost,
and secrecy.
A Limited Company is bound by law to file accounts at Companies House
containing certain minimum information, and to file annual returns (fee
payable), which are then open to public inspection.
A Partnership is not so required, and can keep its affairs (and the details of
the partnership agreement itself) secret from the world in general.
How
do people make partnerships work?
- Know and trust your
potential partner from day 1 at least as well as (if not better than!) you
knew & trusted your husband/wife the day you married him/her
- Always act with 'the
utmost good faith' towards each other. Talk about everything. Conceal nothing.
No other business 'on the side' that your partners don't know about. Give
complete commitment - and expect nothing less.
- Only go into
partnership with others whose professional abilities (& professionalism) you
respect
- Have a partnership
agreement drawn up which records the basis you have agreed. A partnership
without an agreement is an accident waiting to happen!
What makes partnerships go wrong?
- Joint & several
liability - particularly where one partner feels the other was at fault in
allowing the particular liability to arise
- Lack of
trustworthiness, honesty, & openness on the part of the other partner
- When one partner feels
the other isn't pulling his/her weight
The purpose of the partnership must in
itself be lawful:
In 1725 a Mr Everet commenced a partnership
action in the High Court against a Mr Williams. He claimed that the partnership
was 'to deal with several gentlemen for divers watches, rings, swords, canes,
hats, cloaks, horses, bridles, saddles and other things to the value of £200 and
upwards' which 'might be had for little or no money, in case they could prevail
on the said gentlemen to part with the said things'. It was only as the case
progressed that it became clear that both parties were highwaymen. The court was
less than impressed; both later ended up hanged. And a few years later, one of
the solicitors involved was transported for robbery!
The Partnership Agreement -
A list of points you should expect to be
included in a partnership agreement - and which you should discuss, if you're
thinking about it:
- Partners - names,
addresses
- Business - name,
address, nature; existing or new business?
- Term - commencement,
duration
- Initially - who's
putting what in to get it going? money? other tangible things? intangible
things? Goodwill?
- Will capital
contributions be equal? or what? will there be interest on capital?
- Time - who's putting
what in? Whole time/part-time? are other business interests to be prevented?
- 'Revenue' profits &
losses:
- Will there be
partnership salaries? What profit/loss sharing ratios?
- Capital:
- What profit/loss
sharing ratios
- Drawings - are these to
be permitted? rate?
- Provision for interest
on future loans made to partners?
- Bank, requirement for
all funds to be paid in, cheque signing.
- Keeping of books,
rights of access to books by all partners
- Appointment of
accountants, year-end date, provision for dealing with mechanics of accounts,
retention of provision for taxation and growth.
- Execution of
partnership securities - how are things to be signed?
- Meetings & voting,
where majority & where unanimity required, minute book.
- Holidays
- Cars
- Absence
- Insurance
- Utmost good faith -
total frankness, openness, honesty between partners
- Restrictions on
individual partners' powers
- Partners to indemnify
partnership against private debts
- Termination
- Whether partnership
ends or continues if one partner leaves
- buyout of share
- winding up provisions
- Retirement
- Expulsion
- Resignation
- Arbitration
I'd really appreciate your feedback on this
FAQ - so
mail me and tell me what you think of it, if it's been useful to you, or let
me know of any specific problem you have where I may be able to help.
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This page was last updated 21 January, 1996.
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in the information in these pages -
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© Roger Sinclair roger@egos.co.uk
1996 - All rights reserved -
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