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Explanatory Notes
Partnership Agreement (2 partners)
EXPLANATORY NOTES GENERAL INTRODUCTION TO PARTNERSHIP DEFINITION OF PARTNERSHIP Under the English Partnership Act 1890 ("PA") partnership is defined as "the relation which subsists between persons carrying on a business in common with a view to profit". FORMALITIES There are no specific legal requirements that govern the formation of a partnership. The PA governs the relationship unless there is a partnership agreement. Partnership is a private matter and there is no public register that contains any information concerning partnerships. (This is not true of limited liability partnerships which were introduced in 2002 in the UK). LEGAL STATUS OF PARTNERSHIPS A partnership does not have a separate legal personality apart from its members in a way that a limited company does. As a consequence, the partners are jointly and severally liable for the obligations of the partnership i.e. each partner can be sued for the full amount of any liability of the partnership. There is no limit on liability. DUTIES OF PARTNERS These arise from the partnership agreement, where there is one. In addition, partners are both agents of the firm and their other partners. They also have a fiduciary relationship to each other – e.g. a duty to account and disclose information concerning their activities in relation to the partnership. AUTHORITY OF PARTNERS Each partner has the power to bind his partners and make them liable on business transactions which are carried out in the name of the partnership. (This power can be limited internally but if the internal agreement is breached, the partnership might still have a liability to a third party who entered into a contract in the belief that he was contracting with the partnership). WHY YOU NEED A PARTNERSHIP AGREEMENT The answer to this is that without it, there can be uncertainties as to the relationship between the partners and how the partnership should be run. For example, in the absence of a partnership, on the death of a partner, the partnership has to be dissolved. Unless there are only two partners, This might not be in the interests of the surviving partners who wish to keep the partnership going. Similarly, in the absence of any Agreement to the contrary, the partners have the right to share equally in the capital and profits of the business. Problems which can be encountered with the general law can be avoided by a properly drafted partnership Agreement, which can set out clear rules concerning such matters as capital and profit shares, drawings on account of profit, management and decision making, permitted partnership expenses, retirement and expulsion or death of a partner (and the financial consequences of retirement, death or expulsion). SPECIFIC TERMS OF PARTNERSHIP AGREEMENT N.B. Please note that this Agreement contains some clauses with alternative wording and some parts of the Agreement are in square brackets [ ]. It is important to ensure that the final Agreement to be signed by the partners contains only wording that is acceptable to the parties and that all alternative provisions and square brackets have been removed. Similarly, all blanks should be filled in before signature. DATE The date to be inserted on page 1 is the date on which both the partners have signed the Agreement. PARTIES The full names and permanent address of both partners should be inserted on Page 1. INTRODUCTION One of the two introductory sentences should be deleted, depending on whether this is a new business or whether the partnership already exists but there is not yet any formal agreement 1. DEFINITIONS There are various details to be inserted here including the date to which the annual accounts are made up, and a brief description of the business The interest rate to be inserted is the rate of interest payable on partnership capital by the partnership to the individual partners. Since partners frequently raise capital by borrowing from a bank, it is usual for the interest rate under a partnership agreement to be slightly more than the rate which each partner has to pay to his bank. The name of the bank to be inserted in the definition of interest rate will usually be a bank with which the partnership has an account. 2. ESTABLISHMENT OF PARTNERSHIP This clause simply states the date on which the partnership comes into effect. If it already exists, then the effective date of the Agreement will be inserted as per the second alternative. 3. NAME PRINCIPAL OFFICE AND PROPERTY In 3.1 the name of the business is to be inserted and in 3.2 the head office address should be inserted. Clause 3.3 makes it clear that the premises of the partnership (the "Property") and office furniture and equipment is held by the partnership. Where the partnership's premises or furniture/equipment are held in the name of one partner it is made clear that that partner holds such property in trust for the partnership. If there is some other arrangement – e.g. one partner owns the property where the business is carried on and charges rent to the partnership, then this clause would need some adjustment. 4. CAPITAL In this clause the amount of capital which each partner has to contribute should be inserted. The percentage contribution of each partner is also shown, since this can be relevant if percentages are used in relation to voting rights Clause 4.2 makes it clear that any additional capital is to be contributed in the same proportions as the initial capital, and 4.3 underlines this. Clause 4.4 deals with the entitlement of the partners to receive interest on their respective shares of capital. 5. PROFITS AND LOSSES It is usual for profits and losses to be shared in the same proportions as the capital contributions but this is not always the case. The percentage share of each partner should be inserted in 5.1. Under 5.2, if there are any expenses which partners might incur but which are not to be treated as expenses of the partnership, then some adjustment to 5.2 might be required. 6. DRAWINGS It is usual for partnerships to arrange that each partner can withdraw a regular monthly amount on account of his share of profits similar to a monthly salary. This clause deals with this matter, and makes it clear that if there is not enough money in the account, drawings cannot be taken. Similarly, any partner who withdraws more than his profit share for a year must immediately repay the surplus - with interest if the words in square brackets are retained. Often, but not always, a partnership will retain part of its profits to meet the anticipated income tax liabilities of each partner and arrange for the partnership's accountant to settle income tax liabilities with the Revenue & Customs. Clause 6.3 provides that where the tax liability of an individual partner is less than anticipated the balance of any sum reserved is to be returned to that partner. Similarly where a tax rebate is received by a partner in respect of partnership profits he is obliged to repay that rebate to the partnership. 7. PARTNERSHIP LOANS This clause contains a reference to the possibility of one or both partners making a loan to the partnership and in that case, interest at the agreed rate will be payable. 7.2 provides that a loan must be repaid on notice - six months is suggested in our clause. In practice, if any partner does make a loan to the partnership, it would be sensible to have a separate loan agreement dealing with these issues in more detail. 8. CONDUCT OF PARTNERSHIP BUSINESS This is one of the most important clauses as it deals with the day-to-day management of the partnership, and how decisions are arrived at. Whereas in partnerships of 3 or more partners it is prudent to identify those matters that require the consent of all partners and to distinguish such matters from those that may be agreed by a majority of partners, this is inappropriate and impractical for a partnership of 2 partners. Thus clause 8.3 requires all matters relating to the partnership to be agreed by both partners. In addition to considerations of practicality, under the law, individual partners have joint and several liability, i.e. a debt incurred on behalf of the partnership by one partner can result in either of the partners becoming liable to the creditor for that debt. Unanimous agreement thus gives protection to both partners. Paragraphs 8.4-8.7 deal with the procedures relating to meetings and decision making. Note that there is no provision for a partner to appoint a proxy to attend meetings. 9. GOOD FAITH This clause sets out some general obligations on the partners. If either of the partners is only involved on a part-time basis, or if a partner has an interest in another business, then appropriate wording should be inserted to make it clear that the particular circumstances are acceptable to the partnership 10. RESTRICTION ON PARTNERS Following on from the previous clause, Clause 10 imposes a number of specific restrictions on partners: serious harm can be done to a business if one of the partners, without any consultation, makes commitments to third parties, and this clause is intended to avoid those risks. In addition, 10.2 requires a partner who fails to comply to indemnify the other partner so that he does not suffer loss. 11. PARTNERSHIP BANK The name and address of the bank should be inserted in 11.1. The signing arrangements are dealt with in 11.2. 12. ACCOUNTS This clause provides not only for proper accounts to be maintained but also for a balance sheet and profit and loss account to be prepared each year. The firm's external accountants will prepare the annual accounts which will be signed off by the partners. Adequate provision for reserves, etc, will normally be agreed on the recommendation of the accountants and this topic is covered by 12.3. 13. HOLIDAYS Relevant details need to be inserted here. This clause may also be revised to provide for a partner to receive maternity or paternity leave if required. 14. INSURANCE It is important for every business to have adequate insurance in place. The list in 14.2 is indicative only and it needs to be tailored to the business. For example, professional indemnity insurance will normally only apply where the partnership is a firm of professional consultants who might become liable for a negligence claim. If the partnership business is manufacturing, product liability insurance may be appropriate. Note too that the obligation to insure property of the partnership extends to property held in the name of one partner in trust for the partnership. 15. TERMINATION RETIREMENT AND DEATH A fairly long notice period, usually at least six months, and sometimes as long as a year, is customary, when a partner wishes to leave. For accounting reasons, it is helpful for the date of a partner's retirement to coincide with the date of the end of the accounting year. A compulsory retirement age is covered under 15.2. Careful thought needs to be given to the selection of a compulsory retirement age as the partnership may face a claim for age discrimination. As a general rule we do not advise opting for a compulsory retirement age under 65. Under the age discrimination rules introduced in 2006 in the UK, a partnership does not in fact have any right to fix even 65 as a compulsory retirement age. Upon the death of a partner the partnership will be automatically dissolved. A partner who becomes bankrupt, commits a material breach of the Agreement etc., can be required to leave the partnership if the other partner gives him notice. The consequence of this will be to dissolve the partnership. 16. CONSEQUENCES OF TERMINATION This clause sets out the need for a set of accounts to be prepared on dissolution for whatever reason. Both partners will be entitled to whatever is shown as being due to them in those accounts (see in particular clause 16.2). Advice from accountants on the wording of this clause is recommended. Under 16.3, while the same accounting principles will be applied to the termination accounts as to the annual accounts Note at clause 16.5 that where partnership property is held in the name of a partner in trust for the partnership (see clause 3.3) the other partner is given the option to purchase that property before it is put up for public auction. 17. NOTICES The formalities required for giving notice under the Agreement are dealt with here 18. DISPUTES DEADLOCK AND GOVERNING LAW In a partnership of two partners it is advisable to have a formal means to resolve any potential deadlock. This clause provides for either a two or three-stage dispute resolution process - negotiation, mediation and, finally, should the parties agree to include this option, arbitration. Ultimately if at the end of the deadlock procedure the partners are still unable to reconcile their differences, the only realistic option is for the partnership to be dissolved. An alternative to arbitration is to refer the dispute to the courts but in the case of a partnership, litigation between partners could attract publicity and damage the business - arbitration offers a confidential way of dealing with major disputes. The Agreement is governed by English law. See the r Free Information section on our website for more details on arbitration and mediation. 19. ENTIRE AGREEMENT This clause makes it clear that any previous agreements or other arrangements agreed between the partners are of no effect once the Partnership Agreement has been signed. 20. SEVERABILITY A "Boilerplate" clause which deals with the possibility of one of the terms becoming invalid for some reason. 21. WAIVER Another "Boilerplate" provision, which makes it clear that if one of the partners is let off the hook even if he has committed some breach of the Agreement, that will not prevent the other partners from later taking whatever action is allowed under the Agreement .
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