Business Law specialist Frank Scott-Ashe considers why a formal partnership agreement is essential.Contact our Team on 01225 462871 or complete the Contact Form below. |
Partnership agreement
Partnerships are the most common form of business structure. They are akin to being a sole trader, except that more than one person owns and manages the business. You might be surprised to learn that many partnerships lack a formal written partnership agreement.
Partnership Act 1890
Partners face significant legal and financial exposure, particularly if the business arrangement lacks a clear written partnership agreement.
Where no formal agreement exists, or on areas and issues where a formal agreement is silent, partnerships are governed by the terms of the Partnership Act 1890 (“the 1890 Act”). In other words, all or some of the terms of your partnership business arrangement may be imposed by antiquated legislation, exposing you to risks you had not considered. This is because the 1890 Act was not drafted with today’s commercial realities in mind. For example, it does not provide for:
- limited liability;
- the potentially catastrophic consequences of fraudulent or reckless behaviour by one partner without the knowledge of others; or
- clarity regarding intellectual property attribution, which can be essential today.
Despite the risks, and depending on the circumstances, a partnership can still be a flexible business structure. However, it is important to structure them properly and have a comprehensive partnership agreement in place. Here are just a few reasons why a professionally drafted agreement is so important.
Profit-sharing
Under the 1890 Act, partners share profits and losses equally, regardless of their actual contribution of money, time, or risk. Conversely, a partnership agreement allows you to allocate profits fairly, transparently, and in accordance with individual input and responsibilities.
Dispute resolution
Disagreements between business owners are common, often concerning workload, finances, or the direction of the business. Most are minor, but occasionally a dispute can be destabilising or even fatal. Without a partnership agreement, there is no clear plan for resolving disputes.
A formal agreement can specify the decision-making process, how deadlock is addressed, and the agreed dispute resolution process, possibly including mediation or arbitration.
Visit our Legal Services for Business page. |
Partnership dissolution
One major risk of trading without a formal partnership agreement is that any partner can legally dissolve the arrangement at any time, without notice or consent, potentially halting the business in its tracks, freezing bank accounts, and leaving everyone scrambling to salvage what they can against the clock.
A formal agreement offers clear assurance of continuity, with defined exit procedures, safeguarding all parties from unforeseen surprises.
Retirement, death, and succession
When a partner dies, retires, or goes bankrupt, the default legal position is that the partnership is dissolved. Dissolution involves liquidating business assets and distributing them among the partners and the estate of a deceased partner, potentially resulting in significant business interruption.
A formal agreement enables planning for such eventualities, with clear succession pathways and continuity strategies to protect the business’s future.
Flexibility versus risk
Partnerships are easy to set up, provide great freedom in organising and managing the business, and demand much less ongoing administration than a limited company. In terms of finances, there is no requirement to submit annual accounts, and taxation is straightforward through self-assessment.
Nevertheless, all this simplicity and flexibility come with the downside of joint personal liability. Since a partnership is not a separate legal entity like a limited company, all partners are personally liable for business debts. This means that your personal assets, such as your savings and your house, could potentially be at risk from business liabilities.
A formal partnership agreement can help mitigate this risk entirely by outlining individual responsibilities, establishing clear boundaries, and reducing uncertainty.
What should a partnership agreement cover?
We will tailor your partnership agreement to suit your business, circumstances, and ambitions, establishing boundaries and mitigating risks, while preserving the flexibility of a modern commercial partnership.
Among the key areas that all partnership agreements should cover are:
- how decisions are made.
- how profits and assets are shared.
- any capital contributions made by partners.
- how new partners are brought into the business.
- dispute resolution procedures.
- what happens on the retirement, bankruptcy or death of a partner.
What is a limited liability partnership?
Although not the main focus of this article, it is worth mentioning limited liability partnerships, as the term can sometimes cause confusion. A limited liability partnership (LLP) is a different type of legal business structure, distinct from both traditional partnerships and limited companies.
They are a separate legal entity from their members (partners), who are only generally liable for the amount of money they invest. LLPs are incorporated at Companies House and, among other requirements, partners are required to maintain a register of members and provide a registered business address.