Before entering into a business partnership, you should ensure the terms of the partnership are agreed and documented.
Written partnership agreements are typically complex documents, containing a broad range of terms and clauses to cover all manner of eventualities which may not seem conceivable in the early days of the business, but a well-drafted agreement can prove to be invaluable in regulating the partnership relationship moving forward.
The following guide sets out the benefits of an effective partnership agreement, and explains the consequences of not having a written agreement in place. It also sets out the types of provisions that should be included in a partnership agreement.
What is a partnership agreement?
If you plan to carry on a business in common with another person, or a number of people, with a view to profit, then you are likely to be in a partnership. In simple terms, a partnership is presumed where two or more persons decide to work together for profit.
In essence, partnerships are businesses owned by two or more people and are commonly used by various types of professionals, such as doctors and dentists, who can benefit from shared experience, as well as other individuals going into business together.
A partnership agreement sets out the terms and conditions governing the commercial relationship and arrangements between the partners of the business. It should define the duties and obligations of the partners to each other, and to the partnership, setting out the rules by which the internal business of the partnership is to be conducted.
Partnership agreements are also referred to as partnership contracts.
Is a partnership agreement mandatory?
A written partnership agreement is not a strict legal requirement although, for the purposes of clarity as to what has been agreed between the partners, it is advisable that such matters are clearly documented and signed by the parties.
It is not uncommon for people to go into business together without a formal agreement in place as to how their partnership should work, especially when it comes to family businesses, where it is assumed that the individual partners know and trust each other implicitly.
Despite good intentions and amicable relations at the outset, the reality is partnership relationships can deteriorate. This could be due to the pressures of running the business, or where one partner feels they are taking on the lion’s share of work or responsibility, or where the business is no longer considered profitable or other financial or commercial problems have arisen.
It is therefore imperative to set out the basis on which the partnership should work, from who will be responsible for which aspects of running of the business and making certain decisions, to the extent to which each partner will profit from its success or be responsible for any failings.
What are the benefits of an effective partnership agreement?
By having an effective partnership agreement in place, this can provide a whole host of benefits to your business, contributing significantly to how well the partnership works in practice and how smoothly your operations run in both the short and long-term. By clearly formulating the rules of the partnership relationship this can help to:
- Provide the partners with clarity as to how the business will be run, including their rights and responsibilities, and what exactly is expected of them on a day-to-day basis, from how decisions are made to how any partnership disputes will be resolved;
- Determine ownership of partnership capital and assets, and the allocation of profits and losses, where the partners can either agree to share in any profits and losses in accordance with their percentage of ownership, or this division can be equal, regardless of stake;
- Clarify issues of liability and indemnity, where problems arise within the business;
- Minimise conflict and reduce the potential for misunderstanding between the partners in the event of any disagreement;
- Avoid costly litigation in the event that any partnership dispute arises, where the agreement will provide clear written evidence of what has been agreed between the partners;
- Ensure that the partnership is governed by terms tailored to the needs of your business, and each other, rather than the default provisions of the Partnership Act 1890.
What happens without a partnership agreement?
In the absence of a partnership agreement, where the rules of the partnership have not been agreed by the partners in advance, this can often lead to difficulties down the line. If you do not have a written agreement in place, or a comprehensive and effective agreement covering all eventualities, the provisions of the Partnership Act 1890 will come into play.
In essence, the 1890 Act, together with any other relevant legislation and common law, will apply unless there is a clear agreement in place between the partners to the contrary.
The 1890 Act governs the rights and duties of people or corporate entities conducting business in partnership although, more often than not, these archaic default provisions will not be suitable for either you or your business, and can therefore cause serious and costly problems. The Act is well over a century old and, as such, lacks sufficient scope for the wide range of partnership arrangements that can exist in the modern business world.
In broad terms, the Act treats all partners as equals and can therefore lead to undesirable results when it comes to ownership of the partnership capital and assets, the distribution of profit and loss, liability for any debts or wrongdoing, or control and management of the business. For example, the Act dictates that all partners will have an equal say in the firm’s business, often resulting in long and difficult disputes.
Serious problems can also arise where one partner wishes to bring the partnership to an end or passes away. Under the Act, any partner can end the partnership by simply giving notice to the other partners. The partnership will also automatically dissolve if a member dies.
It is therefore vital that you clearly set out from the very beginning the agreed terms upon which you and your partner(s) propose to work together. By putting a well-drafted and comprehensive partnership agreement in place, this will override the statutory provisions that would otherwise apply, allowing the parties to take absolute control of their business in respect of various fundamental matters, including finance, decision-making, liability and dissolution of the partnership.
For those who are already in business together, it is also still possible to draft a partnership agreement to regulate the way in which you have been working, or would like things to work.
What to include in a partnership agreement?
There is no standard partnership agreement that must be used, although it will need to contain certain standard information. This will include the purpose of the partnership and the firm’s name under which the partnership will trade; who the partners are; the date on which the partnership agreement was made, or was deemed to have been made; the duration of the partnership, which may be for a fixed or indefinite term; and the place of business.
It will also need to include key provisions addressing common issues that can arise in a partnership context, including the partners’ capital contributions and profit/loss shares, their rights and obligations, and what will happen when a partner leaves or passes away. That said, every agreement should be tailored to the specific needs of the business in question and the partners involved, depending on how the parties want the partnership to work in practice.
Standard partnership agreement provisions can include:
- The capital contributions of each partner to the partnership, in cash or property.
- The percentage of ownership of partnership property.
- The profit and loss distribution between the partners.
- The arrangements for drawings, banking and partnership funds.
- The way in which financial decisions will be made, including the distribution of profit, allocations of loss and any requirement for additional capital contributions, for example, using a voting system or other method to enforce checks and balances amongst the partners.
- The way in which decisions relating to the management, operation and control will be made in respect of the partnership and its business, for example, through a voting system.
- The ability of one or all of the partners to bind the others, ie; partner authority.
- The requirement and frequency of partnership meetings, including how to call a special meeting to resolve issues that require a vote, and when and where meetings will be held.
- The requirement of one partner to indemnify the others in relation to liabilities incurred in the performance of their duties during the ordinary course of the partnership business.
- The provision of liability insurance for the partnership relating to, for example, partnership property, employers’ and public liability, or professional negligence.
- The partner’s entitlement to annual or other forms of leave.
- The partner’s obligations, including duties of confidentiality, professional conduct and the amount of time that must be devoted to the partnership.
- The extent to which an existing partner may engage in any business, venture or transaction outside of the partnership business, including a duty to disclose of any conflicts of interest.
- The procedure for admitting a new partner to the partnership.
- The procedure for voluntarily withdrawing from the partnership and the impact of a partner’s withdrawal on the partnership.
- The procedure for involuntary withdrawal of a partner from the partnership, for example, through death; mental incapacity; disability preventing reasonable participation in the partnership; partner incompetence; breach of fiduciary duties by a partner; criminal conviction of a partner, etc, and the impact of their withdrawal from the partnership.
- The procedure for expulsion of a partner, for example, where they have breached the partnership agreement; had a bankruptcy order made against them; or no longer hold a professional qualification or certification for the performance of their duties.
- The financial and any other entitlements of outgoing partners.
- The extent to which a former partner may compete against the business.
- The dissolution of the partnership and the distribution of property.
- The way in which partnership disputes will be adjudicated, for example, through mediation.
- The way in which any amendments to the partnership agreement can be made, for example, by unanimous vote only.
- The law and jurisdiction governing the partnership agreement.
This list of provisions, although comprehensive, is not exhaustive. The nature and extent of an effective partnership agreement will depend on a number of factors, including the scope of the proposed or existing business operations and its objectives, the number of partners involved and whether there are disproportionate partnership capital contributions from the outset.
Expert advice from a specialist in partnership law should always be sought on what provisions should be included within a partnership agreement, specific to the needs of both your business and partnership arrangement to ensure that all eventualities are covered.
Once the partnership agreement has been satisfactorily drafted, and its terms agreed by the partners, it must be signed by all parties involved. There is no need to register a partnership agreement but each partner should be given a copy for their own records.
Partnership agreement FAQ’s
What is a partnership agreement in the UK?
A partnership agreement is a written agreement that governs the partnership relationship when two or more partners carry on business together with a view to making a profit. It sets out each partner’s rights and responsibilities, with provisions for how the business should be run. It also provides for what happens if a partner dies or the partnership dissolves.
Why should you have a partnership agreement?
A written partnership agreement will set out in writing the terms and conditions which govern the partners within the partnership business. In the absence of a clearly documented agreement, the provisions of the Partnership Act 1890 will automatically apply, which may not be suitable to meet the needs of a modern partnership arrangement.
Is a partnership agreement legally binding?
A partnership agreement that has been signed by all partners is a legally binding document. This defines the duties and obligations of the partners to each other, and to the partnership, and sets out the rules by which the internal business of the partnership is to be conducted as between the partners. A partnership agreement can still be binding, even if not in writing, although it may be difficult to prove the terms of any verbal agreement.
The matters contained in this article are intended to be for general information purposes only. This article does not constitute legal advice, nor is it a complete or authoritative statement of the law, and should not be treated as such. Whilst every effort is made to ensure that the information is correct, no warranty, express or implied, is given as to its accuracy and no liability is accepted for any error or omission. Before acting on any of the information contained herein, expert legal advice should be sought.