Business partnerships can quickly become complex, especially when there are a number of business partners involved or there is an impact on business operations. Partnership agreements can be used to reduce the potential for complexity and resolve partnership disputes between partners.
Partnerships are a specific legal business structure. Partnership agreements are legal agreements that regulate and stipulate how a partnership entity is run.
This guide is an in-depth overview of partnership agreements. We explore their importance, components, legal implications, and best practices for drafting.
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What is a partnership agreement?
So, let’s define what a partnership agreement is to give you some clarity into this crucial legal document if you are entering into a partnership structure.
A partnership is a form of business entity where two or more individuals operate and manage a business together to share its profits. Partners often contribute capital, skills, labour, knowledge and experience to the business. There are different types of partnerships, including general partnerships in which partners share equal responsibility and unlimited liability.
Essentially, a partnership agreement is a formal legal document that offers protection to all partners and sets out the rules, responsibilities, rights, financial arrangements and liabilities between partners.
Every partnership needs a written agreement for several reasons, they:
Allow partners to limit liability for mistakes by the other parties
Allow control over how finances are managed
Establish dispute resolution mechanisms
Set out each partner’s rights and responsibilities
Can help avoid costly legal issues and unnecessary conflict
It is not a legal requirement for partnerships to be covered by a partnership agreement,
however, when not in place, partnerships are legislated by the 130-year-old, Partnership Act 1890, which has several limitations.
The 1890 act can create many legal and financial issues for modern partnerships.
Firstly, if one partner resigns, passes away, goes bankrupt, or leaves the partnership for any other reasons, under sections 26, 33 and 34 of the act the partnership will end.
This is the case even when the remaining partners wish to carry on with the partnership.
Today, partnership agreements come in many forms and the old legislation doesn’t often cover the scope of modern agreements well.
This is especially true when it comes to liability. Partnership agreements allow partners to assume different levels of liability in relation to their role and the financing they provide. Under the 1890 act, partners are equally liable personally for debts accrued by the company. This could mean that one mistake by a partner could equally impact them all – in worst cases, bankrupting each party.
Bespoke partnership agreements allow more control for every partner and for agreements to reflect the amount of capital and work invested, and they can establish the amount each party profits.
Types of Partnerships in the UK
We’ve already mentioned general partnerships. There are three main types of partnership structures in the UK.
We’ve listed them below:
General partnership – a general partnership is the default classification of a business with multiple owners. A partnership is defined as a general partnership whether there is a written partnership or not. Each partner in a general partnership shares the assets, profits and legal and financial liabilities of the company. Any partner can face the seizure of their assets for unpaid debts and or be sued. Tax is treated in the following ways: the partners report their share of company profits and losses on their tax returns, they pay income tax on these. For partners who work in the business they pay self-employment taxes
Limited partnership – a limited partnership includes one general partner who runs the business and has unlimited liability for any debts the business accrues. Then there are limited liability partners who have liability up to the amount they invested. They are distinct from limited liability partnerships. This structure is often used by individuals pooling their money for investments, e.g. real estate
Limited liability partnership – in a limited liability partnership partners aren’t liable for debts that the business can’t afford. Each partner’s liability is limited to the amount of money they invest in the business. They’re often established by professional services firms such as accountants
There are key differences and implications for each type of partnership agreement. In a general partnership, there is an assumption of good faith between parties. This is not implied in a limited liability partnership, so a partnership agreement helps govern the conduct of partners towards each other.
The key distinction between limited partnerships and limited liability partnerships is how liability is treated. In limited partnerships there is at least one general partner with unlimited liability, however in limited liability partnerships, all partner’s liability is limited by their investment level.
What should be included in a partnership agreement?
When considering drafting a partnership agreement, it’s crucial to evaluate the key elements that should be included.
In this section, we outline some of the most common elements, clauses and terms in a partnership agreement.
Business details
Details of the business should be included, such as the business structure, the names of the individual partners, the registered address of the business, and what the business does.
Capital contributions
The agreement should state the capital contributions made by each partner into the partnership and the percentage of ownership they hold.
Contributions can take the form of cash, property, securities, assets and even skills or knowledge.
Profit and loss distribution
Establish the percentage of profit and loss that is assigned to each partner. Here, also set out how the company will distribute revenue.
Decision-making processes
It is important to set out how decisions are made within a partnership in a partnership agreement. This gives clarity to the operation of the business and removes the potential for conflicts to arise over misunderstandings or differing interpretations.
Terms may set out how the votes are made in the decision-making process, or layout another method to enforce checks and balances between partners.
Partner roles and responsibilities
Another mitigation against dispute. By clearly establishing responsibilities for each partner related to business operations, capital, profits, losses, and liabilities, each partner is bound by the agreement and understands what is expected of them.
Admission of new partners
Over the course of a partnership, there may be circumstances in which the current partners agree that a new partner could add value to the business. There should be a clause in the agreement establishing the specific circumstances in which new partners can be added and the process to follow when doing so.
Withdrawal or expulsion of partners
In addition to guidelines and processes for adding partners, conversely, there must be provisions for allowing a partner to voluntarily withdraw, and a mechanism for removing partners that break the terms of the agreement.
Non-compete and confidentiality clauses
A partnership agreement should contain provisions related to partners who leave the partnership.
A non-compete clause and or restrictive covenant can be included to ensure partners that leave don’t sign agreements with clients, or poach staff. They can also prevent certain activities.
These restrictions should only relate to the interests of the partnership, if they are too broad they become void.
Dispute resolution mechanisms
Most commercial contracts, such as joint ventures and contracts for the supply of goods and services, include clauses for dispute resolution. Dispute resolution mechanisms determine the method of dispute resolution which must be used.
Rather than going to court, disputing parties can attempt a form of alternative dispute resolution (ADR) such as mediation or arbitration.
Dissolution of the partnership
A clause on how the business will be dissolved should be included. It is important to clarify how the company’s profits should be shared between owners if the company is dissolved.
How to draft a partnership agreement
Now you know the terms and clauses that are commonly included in a partnership agreement, let’s consider how to draft the agreement.
Here’s a step-by-step guide to drafting a partnership agreement:
Define the partnership structure, roles and responsibilities
Outline the capital contributions, profit and loss sharing of each partner and liability
Establish provisions for the decision-making process
Set out partner addition and withdrawal processes
Clarify dissolution procedures
Outline dispute mechanisms
Draft no-compete and confidentiality clauses
Outline accounting and taxation processes
Include intellectual property rights
Seek legal advice
Seeking legal advice is important, if feasible it’s best to have legal representation as early as possible. Experienced commercial lawyers can ensure your partnership agreement is legally binding, reduces the potential for disputes and minimises your liability.
A bespoke agreement, tailored to your needs is critical, otherwise without an agreement you will rely on outdated legislation that was not created for your purposes.
How do you update an existing partnership agreement?
Typically, all partners must agree before changes are made to a partnership agreement. Some agreements may specify that this doesn’t need to be the case.
If a unanimous decision is required, all partners should review the terms of the agreement and agree on areas they wish to modify before making any changes.
It’s beneficial to seek legal advice at this point, this ensures compliance with the agreement and protection for each partner. When drafted, all partners must sign the amendments. It’s also crucial that partners communicate effectively throughout the process to streamline the process and guarantee all-round understanding.
Do I need a lawyer to draft a partnership agreement?
Legally, you do not need a solicitor to draft a partnership. However, it is advisable to protect partner’s interests, ensure compliance with partnership law and avoid any unintended consequences.
What happens if a partner wants to leave the partnership?
We’ve mentioned that agreements should include provisions on how a partner can leave the partnership. This may include a ‘lock in’ period where partners cannot leave the partnership. This is usually a risk mitigation against partners leaving during the early days of the business when it is getting established.
Is a partnership agreement legally binding?
Yes, a partnership agreement is a legally binding document. Working with a solicitor ensures that all your key terms and clauses included in the agreement are binding.
Legal services for partnership agreements
Legal and financial liabilities for partners can come to pass if you operate without a bespoke partnership agreement. This is because if you fail to act to incorporate a bespoke agreement you’ll be covered by the outdated 1890 Partnership Agreement.
A well-drafted partnership agreement ensures suitable protection for each partner, a framework by which to operate and legal provisions to safeguard the future of the partnership, allowing you to run it as you see fit.
A partnership agreement solicitor can provide legal assistance and advice to help you draft the most comprehensive agreement possible to suit your needs.
Using our online platform saves you time in finding the right solicitor for you. Our platform allows us to make cost savings which we pass on to you – this is why we can proudly say on average our costs are 30% lower than high street solicitors.
For guidance with a partnership agreement contact Lawhive for a free case evaluation and quote.