James Bailey explains why a properly drafted partnership agreement is absolutely essential for every partnership business.
Many years ago, I was on the phone to a solicitor who was helping me buy a new home. He mentioned that I would need to change my Will, and I had to admit that I did not have one – much to my shame and much to his amusement. He then asked me a question about his own tax, and I said I would need to see his partnership agreement. He had to admit there was none, and I was able to return his mockery of my intestate status with interest.
A proper partnership agreement is absolutely essential for any partnership. You may never read it again once it has been signed, but if a dispute occurs, you will be glad you have it.
Every partnership does in fact have a written agreement, in the shape of the 1890 Partnership Act. This applies to all partnerships (not Limited Liability Partnerships, which are outside the scope of this article) unless the partners agree among themselves that it shall not. How do they so agree? By having their own written partnership agreement.
To take just one example from the Act, section 24 (1) states:
‘All the partners are entitled to share equally in the capital and profits of the business, and must contribute equally towards the losses whether of capital or otherwise sustained by the firm.’
I know of very few partnerships where that is intended to be the case, but unless you have a proper partnership agreement to override this, it will apply to you.
Partnership agreements can also be important for tax planning. For inheritance tax purposes, if one or more partners own the partnership premises or land outside the partnership, they are only entitled to business property relief on 50 % of the value of those premises or land. A little skillful drafting of a partnership agreement can increase that to 100%.
It is worth having the agreement professionally drafted. Do not be tempted to do it yourself, and make sure the solicitor concerned knows what he is doing.
Bear in mind that it is likely the agreement will only be consulted in a case where a real disagreement has occurred, so it is not good enough to work on the basis that ‘we all know what we mean’. In some cases, a badly-drafted agreement can lead to as much expensive litigation as no agreement at all.
There is an awful warning in the case of Ham v Ham ((2013) EWCA Civ 1301).
Mr and Mrs Ham were farmers, and took their son into partnership in 1997. Some years later, their son decided to leave the partnership and according to the partnership agreement, the other two had to buy him out. The question was how this buyout should be calculated – the son said, today’s market value; his parent said, book value (broadly, historic cost). Unfortunately, the agreement did not define how to calculate the value of a partner’s share for this purpose.
Eventually, after the case went to the Appeals Court (at enormous expense, no doubt) the judgement was that the son must be paid full market value for his share. The Court said they reached this conclusion ‘reluctantly’ and that they were sorry that the poor drafting of the partnership agreement had caused ‘so much anxiety and expense’.
Practical Tip:
If your partnership does not have a written agreement, or if it is an ancient document drafted by your grandfather, it is essential to have a proper agreement drawn up by a suitably experienced lawyer. Any cost involved will be more than saved in the event of a dispute in the future.
