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Partnership agreement

Partnership agreement

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Contents

Legal formalities of partnership

There are no formalities that must be complied with to form a partnership. All that is required is for 2 or more people (in this case 'people' also includes legal persons like companies) to agree among themselves that they'll form a partnership. However, if the partnership doesn't have its own partnership agreement setting out all the rules on which it'll operate, it'll be governed by the default rules in the Partnership Act 1890. This Act may also apply if there is a partnership agreement that doesn't cover all the issues covered by the Act.

Advantages of written partnership agreement

It's best to have a written partnership agreement to help avoid disputes later. A convenient feature of the partnership agreement is that it's a private document and doesn't need to be disclosed outside of the partnership.

You're free to decide on any rules or provisions you feel are necessary or suitable for your partnership, and you aren't limited by the Act in your range of choices.

Unless the partnership agreement states otherwise, all the partners have an equal share in the profits of the business, as well as its assets and liabilities. They're also equally responsible for its losses. The partners might want to provide for different arrangements, particularly if their capital contributions aren't equal.

Main clauses

A partnership agreement should address the following:

Capital

The capital of a partnership is the amount or value that each of you has agreed to invest in the partnership. It can be in cash, assets or in services (e.g. a partner's skills, connections or reputation). The amount or value contributed is recorded on a capital account for each partner. The partners should agree on whether they'll hold equal shares in the partnership or whether their share will reflect the proportions in which they've contributed capital. The agreement might also deal with the proportions in which each partner should contribute to any further capital contributions needed in the future.

Partnership profit and losses

The profits and losses of a partnership will be split between the partners after agreeing the annual accounts. The amount of profit that each partner is entitled to or the amount of the loss that they're liable for should be set out in the agreement. If the agreement doesn't state the profit shares, the partners are entitled to equal shares of the profits.

The partners can agree to pay part of the profits made each year as interest on their capital contributions. This would ensure that partners who have contributed higher levels of capital will get higher shares of the profit. If some partners work in the business while others don't, they may agree to pay some of the profit as a salary to the partners who work, so their profits reflect their work input. The partners could decide that after deducting interest and salaries, they'll share the balance of the profits equally or in proportion to their capital contributions.

Drawings

Each partner will have their own personal financial commitments and might not be able to wait until their profit share is determined at the end of each year. The agreement should set out when and how much of the profit each partner can take during the year on account of their annual profit share. This payment is called drawings.

Goodwill

Goodwill is the value of the business's trade reputation and customer base while it continues to operate. Certain items add value to the goodwill of a business. These include contacts, geographical location, the reputation of a business or product, monopoly rights and development potential. If the partnership were to sell the business as a going concern, i.e. while it's trading, a certain amount would be paid for its goodwill. If the partnership were to end its business and just sell off the other assets, it wouldn't realise anything for the goodwill.

The calculation of the value of goodwill is far from scientific, and you may need help from an expert such as an accountant. It's frequently excluded from the annual accounts, since it represents only an estimated, insubstantial value. If you leave the partnership, you may be entitled to a goodwill share and the agreement should provide for this. It'd be a good idea for the partners to agree on how they're going to calculate goodwill and include this in the partnership agreement.

Indemnities

The partnership agreement should contain indemnities. These are clauses that say that the partnership will take responsibility for and protect its partners against any liabilities or claims that they incur while carrying out the business of the partnership. The individual partners should agree to indemnify each other for any losses they cause the others by breaching the partnership agreement.

Expelling a partner

There is no right to expel a partner from the partnership in the absence of an express agreement to this effect. The partners might decide that they want to be able to expel a partner if that partner does specific things. These should be set out clearly in the agreement and how to expel should also be stated.

Rights to payment on termination

The agreement should say how much you'll be paid if you left the partnership or if it were dissolved. It should state your share of the capital, undrawn profits and goodwill. It'd contain a similar provision for how much your estate would be paid if you died while you were a partner.

Property

You need to distinguish between property that belongs to the partnership and property that belongs to an individual partner. The partnership can use an asset that a partner owns, e.g. a building. However, this must be clearly stated in the agreement.

Partnership roles

The partnership agreement should set out specific roles delegated to the partners and what they're authorised to do on behalf of the partnership.

Restrictive covenants

After a partner leaves the partnership, you may want to prevent them from competing with it. In order to achieve this, the partnership agreement can restrict the type of work that they're allowed to do after they leave. The agreement can also prevent them from soliciting customers and poaching your staff. These restrictions are known as 'restrictive covenants'.

Restrictive covenants are only effective if they only protect legitimate interests of the partnership, and if these interests would be damaged without the restrictive covenant.

The main types of restrictive covenants are:

Non-compete covenants

These covenants aim to prevent a partner from competing with the partnership in a particular field and particular geographic area. However, courts are reluctant to uphold them and they won't be upheld if their effect is simply to restrict competition. You must show that the former partner had acquired influence over their customers, and they'll generally only be upheld if there is no other way to protect confidential information. The area within which you bar the partner from competing and the type of work they're prevented from doing must be reasonable. These mustn't be wider than is necessary to protect the partnership from damaging competition.

Non-solicitation and non-dealing of customers' covenants

After the partner leaves the partnership, these covenants aim to prevent them from soliciting the business or customers of the partnership and soliciting employees, consultants or partners of the partnership.

Confidentiality

The partnership agreement should ban a partner from disclosing the partnership's confidential information while they're a partner. It should also ban a partner from using the confidential information and disclosing it after they leave.

Dispute resolution

It's essential for partners to be able to resolve partnership disputes. Therefore, a dispute resolution clause is important in any partnership agreement to avoid disputes that result in lengthy and expensive litigation.

Dissolution

If the partners want, the agreement should provide for the partnership to continue if the events that would normally dissolve a partnership happen, e.g. a partner dying or going bankrupt. There should be clauses dealing with what should happen if one of the partners wishes to leave, e.g. how much notice should they give and whether the remaining partners have an option to buy their share.