General partnerships: key provisions in partnership agreements and why they are important

When two or more individuals decide to engage in business, the corporate structure that will govern their relationship is the first and most important consideration. In a general partnership, two or more ‘persons’ which could be individuals, corporate entities, or both, conduct a business in common with a ‘view to profit’. It is important to distinguish a general partnership from both a limited partnership and a limited liability partnership. When embarking on a general partnership, no separate legal personality is created, and each partner assumes liability for the company’s losses amongst other operational obligations and responsibilities. 

 

General partnerships are often appealing owing to the easy and cost-effective business formation option that does not involve the drafting of governing documents. However, partners are encouraged to enter into a formal partnership agreement to ensure a clear set of rules are in place on how they are to run the business. In this article, we discuss the importance of a general partnership agreement and key provisions to be considered. 

 

Why do you need a partnership agreement?

The Partnership Act (1890) (the “Act”) governs all partnerships in England and Wales and will apply by default where there is no partnership agreement in place. The Act, however, contains general provisions which may not be suitable for every partnership. In particular, the default position under Section 24(1) of the Act is that partners are to share income profits and losses on an equal basis. Although, this arrangement may not be desirable for partners who have contributed unequal amounts to the partnership’s capital and may seek to reflect this by sharing income profits and losses according to their capital ownership. As a result, parties are encouraged to enter into a more bespoke written general partnership agreement that allows for amendments to the standard provisions of the Act to meet individual business structures and requirements. 

 

It is important to note that having a documented general partnership agreement helps reduce the expense of litigation should a disagreement arise between the partners. This is because the agreement provides written confirmation of what was agreed between the parties from the outset of a general partnership, specifying a preferred method of dispute resolution that the parties will be compelled to use. This gives both clarity and certainty to all partners involved.

 

Key provisions

The following provisions are recommended to be addressed in a general partnership agreement: 

 

1. Decision-making

The partners should establish how partnership-affecting decisions will be made. This is relevant to both: (i) day-to-day operational matters, such as contracting with suppliers or (ii) more significant decisions, such as those pertaining to the sale of partnership assets. With the exception of a change in the nature of business or the entrance of a new partner, amongst other matters, which require unanimity of usually at least 75% of the Partners, all partnership decisions are to be taken by simple majority under Sections 24(7) and 24(8) of the Act. Certain partnerships, however, may aim to impose different decision-making norms for particular activities, and may have varying degrees of trust amongst partners. 

 

It is common practise within a partnership to require unanimous consent of the partners before taking any action that might result in more debt, the issuance of guarantees, the sale of company property, or a modification to the provisions of the partnership agreement. Decisions relating to the growth of the company, such as expanding the team, are normally handled by a simple majority. Day-to-day operations, such as the sale of inventory, are often delegated to individual partners without the requirement for unanimous or simple majority consent.

 

2. Allocation of income profits and losses

The partnership agreement should also specify how profits and losses will be distributed among the partners. The conventional position under the Act is that all partners participate equally in the profits and are required to pay equally to the losses. However, the partnership agreement may provide other proportional divisions and complex schemes which can represent the capital contributions made by each partner to the partnership’s capital. In addition, partners may desire to indicate the interest rate that may be permitted on their capital contributions, which will be assigned prior to the distribution of any surplus.

 

If partners are to be compensated for their work contributions, it is essential that this be explicitly outlined in the partnership agreement, along with the partner’s required commitment, such as whether they will be working full time or part time. Partners are permitted to reduce the profit shares of a partner absent for a period of time, a clause to be handled with the upmost care. While the Act does not protect partners in relation to essential employment rights for maternity and paternity leave, your partnership agreement should protect partners by stating that a partner’s entitlement to profits and/or liability for losses remains unaffected. Including provisions handling profit shares and loss responsibilities provides the partnership with a clear guideline on the amount of money to be distributed to each partner prior to the distribution of any excess profit. 

 

3. Duration of the partnership

In the absence of a partnership agreement, a partner may dissolve a partnership at any time by giving the other partners prior notice. This is expected to have a substantial effect on the partnership’s operations and create uncertainty among its participants. Therefore, it is essential that a partnership agreement provides a clear explanation of what events will trigger its dissolution. This may be accomplished by establishing a longer notice period for partners to execute all the logistics, such as negotiating the acquisition of another partner’s stake, so that the remaining partners may stay in the partnership. In other cases, a general partnership may exist for a fixed term or be dissolved following the completion of a specified adventure of undertaking. Alternately, if there are three or more partners, the partnership may continue if two partners remain, regardless of the retirement, death, or bankruptcy of any partner.

 

Partners should also be aware that the Act does not provide a mechanism to expel a partner by a majority of partners. Partners then should agree on powers to determine what circumstances constitute expulsion from partnership and how it would be implemented. Reasons for expulsion can include breaching a term of the partnership agreement or failing to perform duties, amongst other particular grounds. Addressing expulsion, relates to the previous point regarding decision-making and whether partners want unanimous approval or simple majority to handle the situation. 

 

4. Restraint of trade

Non-competition and non-solicitation clauses are commonly overlooked in partnership agreement negotiations. The Act itself is silent on these issues and in the absence of a written partnership agreement, an outgoing partner could establish a competing business. This presents difficulties for the remaining partners, who will need to protect their own commercial interests. It is important to ensure that non-competition, non-solicitation, and non-dealing provisions are expressly incorporated into a partnership agreement to protect the partnership’s business interests. Such clauses must be drafted on the side of caution to ensure enforceability, in particular they must be protecting a legitimate interest and be reasonable in the extent of geographical restriction and duration. 

 

The above list of provisions is by no means exhaustive, and the substance of a partnership agreement relies heavily on the priorities of each party involved. It is therefore sensible to carefully consider the above challenges to ensure that a partnership agreement accurately reflects individual requirements and establishes clarity regarding how the partnership is to be managed.

 

If you’d like to know more about partnerships, require assistance drafting a tailor-made partnership agreement, or further information about corporate governance, we are here to help.

 

Our insights, articles and guides do not, and are not intended to, constitute legal advice or be an exhaustive review of all legal developments. Although every effort is made to ensure that the information provided in this article is accurate as of the publication date, please be aware that this is area of law may be subject to change. Please seek legal advice before applying the information provided to any specific circumstances, transactions or legal issues.