What are partnerships?

What is a partnership?

Put simply, a partnership is the coming together of two or more parties with a view to making a profit. Partnership is used for various purposes. It is common amongst the professions such as law firms, accountancy and medical practices. It can however be as simple as two or more people holding a property for letting purposes, and sharing the proceeds of the income of the property.

Why choose a partnership?

Partnerships are a less formal structure than a registered company. No registration of a partnership is required as there would be with a company. In fact, some people who are in business with others may not realise that they are in a partnership. No formal documentation is required as the partnership itself is created in law when the parties agree to act in concert to make a profit.

The partners are in business together but each is usually liable for their own tax affairs as the partnership itself is not a legal entity and so does not itself pay tax. Compared with a company, the partners will be entitled to take the profits of the practice directly and account for their income directly to HMRC at their individual applicable tax rate. A company however declares a profit which is subject to corporation tax, the balance of which can then be shared amongst shareholders who will also be taxed as individuals when those monies are received. This in effect can create a double tax hit on the profits of the business though shareholders in a company (particularly SMEs) will also often be an employee of that company and receive income under their employment status also.

Companies do have the benefit that, with some exceptions, a shareholder in a company has limited liability. This means that the shareholder’s liability, should the company become insolvent, will be limited to the amount of their investment in the company, and any money remaining unpaid on their shares.

The main disadvantage of a partnership is that the partners are jointly and severally liable for the debts and liabilities of the partnership. “Joint and several” means that a creditor of the partnership may pursue any or all of the partners for the debt. Each partner can therefore be held liable for the whole of the partnership debt.

Although there has for some time been provision for limiting liability within a partnership, it was not without problems and it is only since the year 2000 and the introduction of the Limited Liability Partnership Act that parties have sought to use this route. Unfortunately, I have insufficient scope within this piece to go into detail on LLPs.

Written signed Partnership Agreements

Although partnerships can be formed in law without documentation, it will always be advisable to have in place a partnership agreement. Partnerships formed in law without a formal document providing for continuation of the partnership will end when a partner leaves the partnership. This can lead to administrative problems and problems with third parties who contract with the partnership. A partnership agreement will allow the partnership to continue, removing this issue.

The other benefits of a written signed agreement are that it can set out specific terms on which the partnership is based, a partner’s duties and entitlements, and it can also provide that certain partners may have a different percentage share in the partnership than other partners.

In addition, should any single partner be pursued for the liabilities of the partnership, there will also usually be indemnities within the partnership agreement stating the extent of a partner’s liability as between the partners, with an indemnity between the partners to share the liability between them.

The benefit of contractual terms will provide details of holidays and leave entitlements which if breached can then trigger an entitlement to serve notice on the partner and ultimately to exclude the partner. Where the agreement provides for this and any policy is followed, it then reduces the risk of the expelled partner bringing a claim for breach of agreement.

Managing Risk

The primary risk is the liability in becoming a partner. This can be managed by ensuring that proper processes are followed when a person joins or leaves the partnership.

A person who joins the partnership should do so by way of a document known as a deed of adherence under which that partner agrees to be bound by the terms of the partnership agreement. It is important that the deed or the partnership agreement provides that the partner will not be liable for the liabilities of the partnership arising prior to the partner joining and that this is backed up by an indemnity by the existing partners.

Retirement/Cessation

As with joining a partnership, when a partner leaves the partnership for whatever reason, he or she should seek agreement that the leaving partner will not be liable for the liabilities of the partnership occurring after the date of his/her departure, and should also seek an indemnity from the continuing partners to this effect. This is done by way of a deed of retirement.

In addition to obtaining assurances when a partner leaves a partnership, it is important to deal with protecting the partner from claims by third parties who may not know that the partner has left the business/practice. The risk is reduced by issuing a notice to contracting parties of the partnership, such as suppliers and customers; publishing a notice in local press; and publishing a notice in the official publication, the London Gazette®.

The purpose of notifying other parties prevents that party from pursuing a partner for a claim that has arisen from a cause of action following that partner’s cessation. A notice in the London Gazette would be deemed sufficient notice to prevent a party from pursuing the partner, though to be clear, this will not prevent a claim for matters that have arisen during the time the person was a partner or prior to the date of the official publication. The other forms of notification, local press and person to person communications are less necessary.

The above commentary is not exhaustive and is not intended or should be perceived as advice. Should you have any queries or concerns, you should take legal advice.

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