Pacing your partnership: drafting LLP agreements that go the extra mile

One of your first considerations when setting up a partnership should be to put a legally sound and robust partnership agreement in place to govern the relationship between the partners and set out how the partnership will be managed.

An agreement carefully drafted by a professional can set out a mutual understanding of how the partners will collaborate, lessen the impact of any dispute and pave the way to a resolution.

The most common areas of disputes we see relate to allocation of profit and how the process of a partner exit should be handled.

Standard partnership provisions

There are a number of standard provisions in a partnership agreement, such as:

• Capital contributions
• Profit sharing
• Consequences of default
• Governance.

However, there’s no room for ambiguity in drafting, which is often the most common reason for a dispute. It’s crucial to ring fence the partners’ rights and obligations to specify how decisions will be taken. For example, which decisions must be taken by the partners unanimously and which can be taken by a minority.

The agreement must address not only each partner’s day-to-day responsibilities and decision-making rights, but also what happens after a partner exits the partnership or what happens in the event of a natural disaster.

Drafting trends and considerations

We’re seeing more drafting trends and considerations and suggest considering the following in any agreement draft or review:

• Non-compete, non-solicitation and other general restrictive covenants. These provisions must be carefully drafted to have the right balance. Partners don’t want to appear unreasonable, nor do they want to be too lenient. These are also important in restricting an outgoing partner from taking business from the partnership or important members of staff the partnership may rely on
• Notice periods for voluntary retirement. This helps with the transition upon exit and provides the partnership and other partners with time to prepare
• How profit sharing and drawings should work in an exit scenario. For instance, whether this is through voluntary or compulsory retirement, or expulsion
• How to calculate a valuation when a partner leaves. Valuation disputes are among the most common and costly in partnership litigation. Having a pre-agreed methodology (whether based on net assets, earnings multiples or independent valuation) removes a major source of conflict
• Business continuity planning. This addresses how the partnership will respond to ‘force majeure’ events, disasters or other disruptions. This provision ensures that the partnership can continue operating in a crisis, protecting client relationships and revenue
• Include provisions on structured retirement with notice periods or phased exits, expulsion clauses with defined grounds and procedures, and death and incapacity to ensure partnership continuity. This avoids general uncertainty and helps avoid unnecessary litigation at exit points
• Dispute resolution provisions. There has been a notable rise in tiered dispute resolution mechanisms, reflecting a preference for private and alternative dispute resolution mechanisms rather than going straight to litigation. Agreements now adopt frameworks such as internal negotiation first, then mediation, then arbitration which reflects a consideration on cost. The provision may also suggest that an expert be appointed in certain scenarios, such as a governing body for mediation and arbitration. This provides clarity as to how disputes should proceed.

Drafting a partnership agreement cannot simply be an exercise in meeting minimum standards. It’s also important to adapt to developments in case law and evolving commercial practice. What was commercially viable a few years ago may need to be rethought now.

An increasing trend is to include review clauses, requiring partners to review the agreement regularly, or upon triggering events such as admission or departure of a partner or capital restructure. Including this helps reduce the risk of inadvertently derailing from the purpose of the partnership and ensures that the provisions of the agreement remain relevant.

Checklist

We recommend a well-drafted agreement should address points including:

• Capital and profit-sharing
• Governance
• Deadlock
• Fiduciary duties
• Restrictive covenants
• Tiered dispute resolution
• Admission, retirement and expulsion of partners
• Confidentiality
• Data protection
• Intellectual property
• Valuation mechanisms
• Business continuity.

Depending on the type of business run by the partnership, there may also be other considerations. It’s always worth speaking with a legal adviser who can tailor the agreement to the scenario best suited to the needs and expectations of all partners.