How to avoid partnership disputes

Posted onOctober 17, 2018

Situated opposite the Royal Courts of Justice and a stone's throw from many central London courts, Saunders Law is well placed to deal with all aspects of commercial litigation. The firm is well known for its client satisfaction and customer service, and for guiding clients through very difficult and testing commercial disputes.

Our litigation solicitors have decades of experience and are regularly required to assess and advise on many types of partnership disputes, in particular general partnerships and partnerships at will, but also limited liability partnerships.

Disputes in partnerships are common, and can arise for many reasons. Often partnership disputes result after: many years of issues bubbling in the background suddenly coming to a head; or due to technicalities in the law, usually when one partner wishes to leave; or the other partners want to evict a partner and realise they can't; or over asset disputes.

Due to their peculiar nature, and often high stake implications, partnership disputes require careful assessment and handling as soon as a potential dispute seems likely, especially where the future of the business hangs in the balance.

The article below touches on some key issues partnerships and steps that might help protect against a full blown dispute arising.

If you require assistance resolving a partnership or general commercial dispute, please give us a call on 020 3553 0702 to see how we can assist.

Partnerships can arise unintentionally

A common issue in partnership disputes can be paradoxically, as parties do not always realise that they have entered into a partnership.

People often take a leap with a friend, colleague or family member, and set forth on an exciting new business venture, pursuing a passion as a business, and sharing the proceeds as they go. Sometimes this arrangement can work well for many years before any issues arise.

Lack of formal arrangements

Due to the excitement and promise of prospective profit, the details of how a business is intended to work are often hastily thrown together. Often some initial details are discussed at pace, but not written down, but are taken "as read" and parties presume that it is clear who owns what. Parties can do business together for many years based on little more than a handshake.

Definition of a partnership is very wide

Partnerships can arise unintentionally, as the legal definition of a partnership is incredibly wide, and covers broadly "two or more parties, carrying business together with a view to making profit".

That covers a whole host of commercial arrangements, outside of dealing via a company structure. If parties do not expressly state they are in a partnership, this may still constitute a "partnership at will" in law. The courts look to the facts, rather than the stated intention, and partnerships are often found to exist where none were originally intended.

Unintended consequences

It is often, only many years later, when a party tries to pull out of this arrangement, or tries and cuts ties with the other person, that they discover they have in fact been operating in a partnership with ill defined terms, and that, absent express agreement, statute implies various conditions which prohibit ideal commercial objectives, and which may lead to expensive disputes arising.

Partnership Act 1890 (PA 1890 / the Act) and implied terms

Absent formal agreement, or a centralised agreement, the Partnership Act 1890 likely applies to general partnerships at will.

It is often queried how can an Act from 1890 hope to meet current commercial activity, but until the law is updated, it continues to apply, and offers some predictability of outcome, albeit not necessarily ones the parties may have intended. For example:

The Act provides that a partnership which is not for a single business deal, or of a fixed duration, may last indefinitely and require notice to terminate pursuant to the Act.

PA 1890, s24(1) says, absent agreement to the contrary, all partners are entitled to share equally in the profits of the business and are required to contribute to any losses, either income or capital.

There are accounting requirements implied under the PA 1890 at least on some level, but do not necessarily need to be audited accounts.

S.5 of the Act outlines that each partner is an agent for the firm, and liable for commitments entered into by other partners, including contractual liabilities and debts.

If a partnership is established in law, a fiduciary duty is established between the parties, i.e. a requirement that each partner has to act in the utmost interest of the other partners. Partners have to act in each other's interests generally, account for profits, and not put themselves in a position where duties conflict. These duties apply until the firm is finally wound up.

Absent any express agreed terms, it may be impossible to compel a partner to retire against their will, and doing so may require dissolution of the partnership altogether, or agreeing an unwelcome, high monetary incentive.

A partner can apply to court under s 35 of the Act to dissolve the partnership if:

Another partner is permanently incapacitated;
A partner conducts business with a view to prejudice the partnership;
A partner consistently or purposefully breaches requirements in law;
The partnership is being continued at a loss;
That there is some other good reason to do so;

However, the court will have regard to all the circumstances, and if the grounds for dissolving the partnership are arguable, this can increase the risk of litigation being found against you.

Disputes as to assets / dissolution

Disputes can arise even in well-established firms of professionals, where there have previously not been any other disputes, over liquidating assets and liabilities.

Absent a formal written agreement as to who owns what, and how to dissolve a partnership or evict or retire a partner, the fall-back statutory position can have unforeseen and very expensive consequences.

Whilst partners can retire from the partnership with notice if they want to, as above, other partners are not able to force a partner to retire absent agreement in advance, and may only be possible by dissolving the partnership or by negotiating a high golden handshake for the partner. If the partnership is dissolved to exclude a partner, that partner would still be entitled to fair value payment.

Absent agreement to the contrary, the fall-back position is that the partners may be entitled to shares in assets and liabilities equally, and which may not reflect the reality of contributions, and which may be disputed.

There may be disputes subsequently, who owns what and in what proportion, and what items or considerations form partnership assets, and which are personal to a particular partner.

If a dispute arises, this may require expert or court intervention to establish the matter legally, and which can be timely, expensive and stressful.

Absent clear agreements in writing, high value partnership disputes can be won or lost based on a hazy conversation, undocumented, that one party alleges to have happened on a stairwell in 1970 around 9am on a Monday morning, for example.

What precautions may help to avoid partnership disputes?

Take early legal advice

A key precaution, ideally before the event, (but could be helpful after the event), is to take early legal advice before you enter into a new business venture, as to what structure would work best. Is a general partnership your best option, or some incorporated structure, or something else?

What type of partnership?

If you decide a partnership suits you best, what type of partnership works best. There are different types, which quite radically different implications as to liability: limited liability partnerships, limited partnership and general partnership, plus others.

Set up a basic partnership agreement in writing

It is worth investing some time to work out the basic terms of a partnership preparing for both the good times and the bad. Even a modicum of planning could save a real headache later on.

There is a need to plan for the worst as well as best cases scenarios: what happens if the partnership needs to be wound up. What happens to employees if another partner buys the partnership? What happens if one partner becomes insolvent, but the others don't? How could you eject a partner if necessary? What happens to assets if a partner dies?

It plans to plan expressly, and to have some certainty of process, rather than being subject to a 130 year old act and case law.

Regularly review the agreement against the commercial reality

As with all businesses, partnerships can adapt and change substantially over time, and what worked well for the initial set up, might be less secure going forward. It is worth renewing the historic agreements fairly regularly to see how they might need amending from time to time.

Clearly define which assets belong to whom

Assets owned by the partnership or individual partners might become blurred, and some might greatly increase in value. New partners might join, and others might leave. What does that mean for asset sharing and apportionment? It is worth keeping records and taking advice to ensure the position is clearly set out.

Post termination restrictions

If a partner can be evicted or opts to leave, it is worth realising they might want to compete with the former partnership, and set up a competing business nearby. This can pose logistical issues when the name of the original partnership contains the surname of the partner leaving, for example. It is worth factoring in garden leave requirements and non-solicitation clauses in advance.

If it is too late for hindsight, and you have a partnership dispute that is about to erupt, early legal advice is key.

At Saunders Law, we're dedicated litigators with vast experience assisting clients to resolve their commercial disputes, including partnership disputes.

For a free, no-obligation, initial discussion of how we may be able to help, please contact us on 020 3553 0702 to see how we can assist or make an online enquiry.