How to draw up a Partnership Agreement
Without a formal agreement, a partnership must, by law, cease trading and be dissolved on the death of one of the partners. This means that on the death of any partner, all assets liquidated and the proceeds distributed equally between the living partners and the estate of the deceased, regardless of their contribution. Surviving partners do not have any rights to buy the business assets or continue to trade.
A formal partnership agreement allows the business to continue to trade and ensures the deceased beneficiaries receive the best value for the deceased’s holding in the business.
What does not having a formal agreement mean?
Any commitment given by one of the partners is binding on the other partner/s (even if the other partner is not consulted). Similarly any action an employee takes commits (and makes liable) all the partners equally.
The partnership will be immediately dissolved and must cease trading if:
- If one of the partners gives notice he is quitting; there is no minimum notice period, and the notice does not have to be in writing, it can be spoken;
- In the same way, the death of a partner immediately dissolves the partnership;
- Expelling a partner for fraud would have the same effect;
- Taking on a new partner would also dissolve the partnership.
With the business dissolved and ceasing to trade:
- All assets have to be gathered in, liabilities assessed and paid off and whatever is left is divided equally between the partners of the original business.
- If it was death that had caused the end of the partnership, then the monies are paid out in equal shares to the surviving ex-partners and the deceased’s estate.
- When all the partners are living there may be room to negotiate, but when one of them dies, the options disappear, especially if the beneficiaries are minors.
The executors of an estate have a legal obligation to maximise the benefit for the beneficiaries.
As a result the death of a partner can cause serious problems for the remaining partner/s.
- The executors or trustees of the deceased’s estate may refuse a request by the other surviving partners to sell them the deceased partner’s share.
- Personal representatives may insist that all the assets are sold and distributed with the remaining partners having no right to acquire the assets at valuation.
- The executors may insist that the assessed value of the deceased’s share of the business be paid immediately to the estate; this could prove financially ruinous to the other partners.
- If they leave the deceased’s shares in the partnership, executors run a risk that they could be deemed to be partners in a new business, with ongoing consequences.
- The deceased’s estate remains liable for debts or liabilities incurred before the partner’s death, so this is likely to slow up the distribution of the estate.
Draw up a Partnership Agreement, where what happens in various situations is not only agreed but also understood by all Partners.
For most partnerships the agreement will also cover a number of important additional areas. These can include:
- Is the partnership to last indefinitely or for a fixed period?
- What is the management structure for the partnership?
- What are the rules for holidays, sickness, and maternity leave etc.?
- What assets are owned by the partnership?
- If partners have leant money to the business, what are the rules on interest and repayment?
- How are profits distributed between the partners? Can the rules be varied?
- Is the business to be independently audited every year?
- Is there a compulsory retirement age?
- How badly does a partner have to behave before they are automatically expelled?
- What are the rules on partners buying each other out?
- How will the business be valued in a buy out or death situation?
- Does payment have to be made immediately, or is it staged?
- Can one partner dissolve the partnership or dues it need a majority?
- If the partnership is dissolved, how much notice needs to be given?
- What are the rules on resolving disputes?
- Are new partners allowed in the future? If yes what are the rules for selecting new partners?
- If a partner leaves, what are the rules on them setting up in competition?
- What insurance must business and individual partners have to have in place.