The Importance of having a properly drafted partnership agreement

Commercial Solicitor Paulina Jastrzebska explains the importance of having a properly drafted partnership agreement, as well as what it should include.

What is a partnership agreement?

Partnerships are a set of personal and commercial relationships between individuals (could be family members, close family friends or best friends) carrying on a business in common with a view to profit.

It is advisable that these relations are regulated by a correctly drafted partnership agreement setting out the commercial terms of the business relationship between the partners.

The purpose of a partnership agreement is to:

  • protect the owners’ investment in the partnership;
  • govern how the partnership will be managed;
  • clearly define the rights and obligations of the partners, and;
  • determine the rules of engagement should a disagreement arise among the parties.

A well-written partnership agreement will reduce the risk of misunderstandings and disputes between the owners.

Can a partnership agreement be oral?

The Partnership Act 1890 (PA 1890) forms the basis of today's partnership law. Although the PA 1890 covers most of the necessary ground in setting up a partnership, it does not cover all of it.

Where there is no written agreement, the provisions set out in the Act (some of its provisions are outdated) apply instead and the default position set out in the Act may not be attractive to the partners. Therefore it is always advisable for partners to enter into a formal partnership agreement.

What should a partnership agreement include?

The management of the partnership, the ownership of partnership property, sharing of profits and losses, dispute resolution, how to dissolve the partnership are just some of the things which should be included in a written partnership agreement.

The management of the partnership (control and day to day management)

A partnership agreement clearly sets out who owns what percentage of a business. A partner who contributed more capital into the business might be considered as a managing partner and might take more of the responsibility in exchange for more of the profit and be less involved in day to day management.

However, without a written partnership agreement, the default position on day-to-day management of the partnership is that this is done by all the partners with decisions made on a majority basis.

The ownership of partnership property

It is important to specify what property belongs to the partnership and what belongs to individual partners in the event of partnership dissolution there is a clear division of assets ownership between the partnership and individual partners.

Profits and losses

Unless there is an agreement providing otherwise, all the partners are entitled to share equally in the profits of the business and must contribute equally towards the losses whether of capital or income.

In practice, there will be many variations which partners will want to make to this default provision. Shares of profits may be unequal, capital profits may be shared in different ratios to income profits and losses may be treated differently from profits. It is important to determine any special rules by which profits or losses are to be calculated.

Dispute Resolution

When disputes arise between partners, the options are to either resolve the dispute or dissolve the partnership. The partnership agreement can provide that the partners must undergo mediation or another form of dispute resolution to try and reach a resolution before dissolving the partnership.

How to dissolve a partnership agreement

Dissolution of a partnership occurs when the partnership relationship terminates. Partnership agreements should set out the terms on which the partnership can be terminated and how assets and interests are dealt with upon termination.

A "technical" dissolution arises when one partner leaves and/or another partner joins, but the business carries on under a new partnership arrangement. In effect, the old firm has dissolved and been replaced by a new firm of partners which will take on the assets and liabilities of the old firm and the business continues without a break.

If there is a dispute which cannot be resolved and a partner is being difficult about leaving, the partnership would need to be dissolved if there is no partnership agreement.

Retirement and death

The death of a partner in a general partnership dissolves the partnership completely. However, a partnership agreement can provide that the partnership will not dissolve upon death, unless there are only two partners. In case of the retirement – without a written partnership agreement there is no right to retire without dissolving the partnership.

Paulina says

"Having a well-drafted partnership agreement by professional advisers means that the partnership is created and managed correctly. The other advantage is that there will be fewer opportunities for disputes because the partners have already set their own rules and procedures - this can save legal fees and litigation costs in the future.”

If you are setting up a partnership or have already set one up and need professional advice on a partnership agreement or any issue in connection with a partnership, please contact our Corporate and Commercial Team for a free initial consultation at our Christchurch or ​Ringwood offices - call us on 01202 499255.