The importance of a partnership agreement

15th May 2024

The only legal definition of a partnership is where there are “persons carrying on a business in common with a view to profit”. There is often a fine line between whether there is a joint venture or a partnership between parties (unless set up formally such as a limited liability partnership (LLP) or a limited partnership (LP)), and it is not uncommon to find that people have been trading in a partnership without realising it.

Partnerships can raise some of the following questions:

  • What happens in the event of a dispute between the members, if there is a claim made against a member or even how the business is perceived?
  • What if the members are of the same family?

There is often more than just tax and legal factors to consider, and the partnership agreement is a good starting point.

Partnership agreements

There is plenty of case law to suggest that the actual facts, actions of the parties and the circumstances can play a part in deciding whether it exists or not. Not only that, but a poorly drafted agreement may have an outcome not originally intended.

Whilst there is no requirement to have a partnership agreement, and even where an oral agreement can suffice, formalising a partnership with a documented partnership agreement has two clear advantages:

  1. Firstly, it focuses the parties’ minds on the nature of the transaction, and if the situation as to whether a partnership exists is borderline, the agreement may decide the matter.
  2. Secondly, there are sound practical reasons for putting the arrangement in writing to ensure that the subsequent business transactions are what the parties agreed to at the outset. This could include, for example, where the parties disagree on a matter, or their profit-shares may cease to reflect their continuing contribution, appointing new members or expelling disruptive members.

We should also keep in mind that in the absence of a partnership agreement, or in cases where something is not covered by one, we default to the rules as set out in the Partnership Act 1890, which may not give the results the parties intend.

Main contents of a partnership agreement

There are many points that will need to be covered and some will vary according to the type of business and the relationship between the members.

However, the agreement should be clear on whether there is a partnership and how the arrangement is to work. Some agreements run into hundreds of pages whereas others are just a few pages long. In general, factors such as how the members will share income and capital profits, what happens on the death of a member, putting restrictions on exiting partners, capital contribution requirements, and more will all need to be considered.

A small investment in legal and tax advice at inception can protect the partnership against a much more expensive battle if the parties later decide to split up. For further advice, contact Kiran Chotai, Private Client Senior Manager.

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