In the absence of an express partnership agreement, the terms on which a partnership operates will be implied by law under the Partnership Act 1890. More often than not, if you are planning to go into business with someone you like and trust, taking the time to draw up a written partnership agreement may seem like a waste of time and money. However, while making decisions from the outset about what is to be done in the event of a disagreement may be difficult, the drawing up of a partnership agreement can actually help you avoid a less than desirable end to a partnership should relations between yourself and your business partner(s) deteriorate at some point in the future.

The Partnership Act 1890: Main Provisions at a Glance

1. Leaving the Partnership

• If there is no express agreement as to duration, the partnership is a ‘partnership at will’ and can be brought to an end at any time simply by one partner giving immediate notice to the other partner(s).

• Unlike a limited company, no partner can simply withdraw or retire or sell his/her interest to an outsider (assuming one can be found). Therefore a partner deciding to leave will result in the automatic dissolution of the partnership.

• If the partnership is dissolved, the business can either be sold as a going concern or the individual assets sold. In either case, the proceeds are used to pay off the partnership’s debts and the balance is used to return capital and other amounts due to the partners. Any remaining balance will be distributed amongst the partners in their profit sharing ratios.

• There is no automatic right for the remaining partner(s) to acquire the departing partner’s share, nor any mechanism for valuing that share.

• It is worth bearing in mind that, should a partner unexpectedly die, this will also result in automatic dissolution of the partnership.

2. Expelling an Existing Partner

• There is nothing in the Partnership Act 1890 which allows one partner to expel another for whatever reason.

• In the event of the relationship deteriorating beyond repair, a partner cannot simply be replaced therefore, unless agreement can be reached, your only option will be to dissolve the partnership and start again from scratch.

3. Decision Making

• Under the law, some decisions require unanimity (ie. the introduction of a new partner), while other decisions regarding the day to day running of the business can be made by a majority of partners.

• Unless there has been an agreement to the contrary, most decisions can be made by a majority. Therefore, in a partnership of three or more, you may run the risk of being out voted by your fellow partners in respect of key decisions that affect the value of your partnership share, such as the future direction of the business.

• Bear in mind that all partners are jointly and severally liable without limit for debts incurred whilst they are partners. A bad business decision could result in you being personally made to pay all the debts of the partnership, regardless of whether you agreed to the flawed business plan or not.

4. Division of Profits and Losses

• In the absence of an agreement to the contrary, all partners will have an equal share in all profits and losses of the partnership. This applies to both income and capital.

How A Written Partnership Agreement Could Help

By thinking ahead and putting into writing how the partnership is to operate, a carefully drafted partnership agreement could make provision for just some of the following;-

• an option to buy a fellow partner out should they decide to leave the partnership;

• an agreed formula for valuing a departing partner’s share and a mechanism to stagger payments over a period after his or her departure;

• a procedure to ensure a smooth transition in the event of the death of one of the partners;

• the power to expel an unruly partner from the business in the event of a fundamental breach of the partnership agreement;

• a fuller and clearer definition as to what business decisions require unanimity and what decisions can be made by a majority; and

• for capital and income profits and losses to be shared between the partners in the proportions in which they each contribute to the partnership.

Our Advice …

In our experience it is always better to reach an agreement and put this in writing when relations are still amicable. Take the time to prepare a properly drafted partnership agreement at an early stage. If you don’t you may run the risk of incurring a great deal more cost, wasted time and difficulty!