Partnerships In The Family Business
2nd February 2015 Nicola Marchant, Pannone Corporate
Family members and husband and wife teams who are in partnership together are being urged to put formal ‘partnership agreements’ in place to help safeguard their future in the business.
Such agreements setting out parties’ liabilities and responsibilities are standard in other business structures such as companies and LLPs (Limited Liability Partnerships). However they are often overlooked in partnerships which still remain common vehicles for running family businesses.
In partnerships, partners are the owners of the firm, responsible for driving its success and in exchange they share the profits and liabilities.
However, lack of formal partnership agreements between partners in the family firm can result in lengthy and expensive battles and, in these tough economic times, we have seen a significant increase in disputes between family members.
Often when family members start out in business they are united by a common goal. However, as often is the case, relationships can breakdown over time. Disputes can arise for a number of differing reasons such as disagreements over direction and strategy of the business. Also over workloads where some feel they are contributing more to the business than others.
All too easily one or two members are ostracised from the management of the business and, without proper formal partnership agreements in place, disputes can arise over their entitlements.
Without a partnership agreement, a partnership can easily be dissolved by one member without the consent of the other, simply by serving a letter on the other party. Dissolution is the process whereby the business is wound up with all the assets being sold and liabilities being discharged.
We have seen parties on the brink of a divorce and indeed other family members - in one case a member who was close to the retirement age - simply dissolving a partnership out of spite leaving his brother-in-law without an ongoing business or income.
A properly drafted partnership agreement should set out how to deal with these situations. However, the fact remains that most family business partnerships do not possess such agreements and, in firms where husbands and wife are in partnerships together, they are practically non-existent.
Unless the partners have agreed and signed a partnership agreement, or have written evidence of what has been agreed between them, the partnership is governed by the Partnership Act 1890.
Therefore when family members decide they can no longer work together, they are left to rely on this archaic Act.
Partnership Act 1890
The Act is basic and is only nine pages long. In contrast, partnership agreements are usually no less than 20 pages long. This simplistic comparison helps to illustrate that a partnership agreement rather than reliance on the Partnership Act should deal with the majority of scenarios which can arise in a dispute.
There are a number of key principles which the Partnership Act 1890 confers on partnerships if no alternative agreement is reached between the partners:-
- it requires equality between the partners including relating to profit share
- no majority of partners can expel another partner
- the death of a partner will automatically dissolve the partnership
- any partner can dissolve the partnership at any time
At first glance these do not perhaps appear to be especially draconian provisions. However, if you have not agreed a provision for expulsion of a partner then a situation can and often does arise where one partner can be failing to carry out his share of the workload and yet will be still entitled to an equal share of the profits.
By contrast, partnership agreements will expressly set out the requirements of partners so that all partners are fully aware of what is expected and any potential consequences of failing to fulfil those expectations.
Dissolution of a partnership
Under the Partnership Act, if agreement cannot be reached between the partners as to the retirement of one or more partners then the only way to bring the partnership to an end is by way of dissolution.
The ramifications of dissolution are that the partners are required to divide up the business, sell the assets of the partnership including equipment and premises. Contracts with employees are terminated and the partnership can face redundancy payments or dismissal payments.
Further, dissolution triggers the obligation to immediately repay any loans and overdraft facilities and can lead to advance tax payments. To leave such an outcome in the hands of any one partner who is not bound by a partnership agreement puts the business and the other partners’ livelihoods at risk.
A formal partnership agreement will mitigate the risk of potentially having to engage in time consuming and expensive disputes in the event of a breakdown in the family relationship.