Beware of ‘partnerships at will’!
A partnership without a written agreement is a ‘partnership at will’, which is governed by the Partnership Act 1890 (the “Act”). This type of partnership is inherently unstable and commercially undesirable as:
- Notice to exit or dissolve the partnership may be served by any partner without the other partners’ prior knowledge or consent;
- This notice can take immediate effect;
- This notice could result in the forced sale of all partnership assets, redundancy of all staff and significant financial liabilities; and
- Following dissolution, there are no restrictions on any partners as to what they can do with the goodwill or intellectual property of the partnership.
Here, we look at some of the major pitfalls of partnerships at will and provide some practical ideas for partners faced with a potential dispute.
Is there a partnership?
In the absence of an express, written agreement, whether a partnership actually exists depends on the relationship between the parties involved and not just what they believed the relationship was. When determining whether there is a partnership, the court will consider a number of issues including, but not limited to:
- The purpose of the business. The Act defines a partnership as “the relationship which subsists between persons carrying on a business with a view of profit”. It does not mean that the partnership actually has to make a profit; only that it was the intention to do so;
- Whether there is a clear consensus of intent between the parties;
- If the relationship is more akin to employer / employee;
- Whether a partner is salaried or receives a share of the profit of the business; and
- The actual day to day running of the business.
It is imperative that, where possible, accurate records are kept of the day to day running of the partnership to evidence the true nature of the relationship between the parties.
Unless there is agreement to the contrary, a partnership at will calls for equal division of all of the capital, profits and losses of the business. This is often not what the parties have intended. A partner has a wide authority to bind the partnership and can therefore bind it to a range of commitments in the ordinary course of business. It is at this stage that partners, who are keen to avoid their potential share of these liabilities, may seek to argue that there was never actually a partnership at all.
Who owns the partnership assets?
No partner has a right to an asset used by a partnership. As such, on dissolution of a partnership, without a written agreement, any assets will be sold and the proceeds used to pay off any partnership debts. Any surplus funds are then divided between all of the partners in the proportions in which they are entitled, i.e repayment of loans and capital and then any residue is shared in the profit shares during the partnership.
Such scenarios can quickly turn litigious with partners claiming that there was an express and/or implied understanding between them that the assets would be divided in some other way and a partner has relied on this promise to their detriment. It is therefore vital to be able to determine whether an asset is a partnership asset or belongs to an individual partner.
What happens to the goodwill in the partnership?
On dissolution the partners may complete any unfinished business for the partnership in order to maintain the value of the goodwill. That goodwill will then be sold as part of its dissolution unless a partner wishes to purchase it.
This poses no real difficulties for partnerships involved in the retail sector. Problems mainly arise in relation to professional partnerships (i.e. legal, financial or the private health sector) where a partner will claim ownership of the goodwill and wish to retain the same and/or claim a larger share of its value.
A common example is where one partner has a well established reputation of his own of which the partnership has been allowed to make use of. Similarly, where the partners have separate lists of customers and service them individually (i.e. a patient list in a dentist’s surgery). In these circumstances, a court is likely to order that each partner will be deemed to own the goodwill of the partnership and/or their own customer lists, unless there is evidence otherwise.
Whilst this appears to be the fairest way in which to proceed, this could have a significant, financial impact on the value of the partnership and the ultimate share outgoing partners will receive. As such, it is vital to establish exactly what each party is entitled to before this issue arises.
Post partnership restrictions
Restrictions are usually included in partnership agreements with the aim of preventing an outgoing partner from poaching clients/customers/suppliers/other employees, and/or dealing with former clients/customers/suppliers.
However, unless there is a written agreement to that effect the law does not imply any post partnership restrictions on outgoing partners. As such, a partner is free to poach any customers or suppliers of that previous partnership. This is likely to create significant difficulties where partners intend to continue in the same industry or set up a competing business in the same geographical area