There are a broad variety of partnership agreements that can exist and one should be put in place for several reasons. From preventing future costs, clarifying liability and avoiding the Partnership Act 1890, this article works through five key reasons why you should have a partnership agreement.
1 – Avoiding the Partnership Act 1890
In short, a partnership agreement is not required by law but if you enter into a partnership without one, the partnership will be governed by the Partnership Act 1890. The Act is over 120 years old and lacks sufficient scope for the broad variety of partnership arrangements that can exist. Fundamentally, the Act treats all partners as equals and can therefore lead to undesirable results. For example, under the Act, all partners have an equal say in the business which can lead to long and often unresolved disputes. Putting a partnership agreement in place will immediately override the provisions of the Partnership Act allowing parties to take control of their business from several angles.
2 – Preventing future costs
Having a partnership agreement can significantly reduce future costs that may be incurred when resolving a dispute between partners. If something goes wrong, the agreement provides a process to follow. A likely dispute may include the value of various intangible assets and intellectual property or the procedure to follow on the retirement of a partner. Establishing who owns what in this context can be challenging and costly. A partnership agreement would therefore minimise these costs.
3 – Finances
Without a partnership agreement, the assets of the partnership belong equally to partners which may not always be desirable. For example, if one partner contributes more capital into the business and does more work, it would seem unfair for there to be equal financial entitlement for the other partners. It is possible to have varying degrees of profit and loss sharing in a partnership agreement.
4 – Taking control
One key aspect of the Partnership Act 1890 that owners may want overridden in the Agreement is that any partner can end the partnership just by giving notice to all other partners, and that the partnership dissolves if a member dies. It is therefore desirable for partners to enter into a partnership agreement where issues such as dissolution and incoming and outgoing partners are addressed with terms agreed by the owners at the outset. Without this overriding agreement, the Act will govern these processes.
5 – Liability
Joint liability can prove to be problematic in a partnership that lacks an agreement. Without an agreement dictating otherwise, a partner may enter a risky contract and should that contract go wrong, that partner, and all the other partners will be equally liable for those debts. It is possible for a bad business decision taken by a partner to cause bankruptcy of other partners who were not at all involved with it. A partnership agreement can be drafted in such a way as to prevent such occurrences.
It is clear that quite serious problems can arise if there is no partnership agreement in place to set a direction for the partnership in respect of control, finances and liability. Unless you would like to rely on the Partnership Act 1890, your partnership needs a partnership agreement.