Partnerships

Question 1

what is the definition of a partnership?

Answer 1

a relationship between two or more persons carrying on a business in common with a view to making profit

Question 2

how is a partnership formed?

Answer 2

there are no formalities to form a partnership - it can be done in writing, orally, or by a course of trading with a view to making profit

there does not have to be an intention to make a partnership

Question 3

what are factors in determining if a partnership exists?

Answer 3

Factors indicating partnership exists:

• profit sharing (not conclusive)
• agreement to share losses and profits (more likely)
• all individuals taking part in decision making
• partners holding themselves out as partners

Factors indicating a partnership does not necessarily exist:

• loan by one party to another
• if a person is not being held out as partner

Question 4

what are the overall advantages (5) and disadvantages (3) of a partnership?

Answer 4

advantages:

• no formality = partnership can be formed without formal agreement or intention
• speed = two people with a view to making profit can start trading immediately
• there are no set-up costs so less expense
• there is a high degree of confidentiality regarding the business affairs as there are no filing or disclosure requirements
• more control and flexible organisational structure as partners can decide on how to run the business

disadvantages:

• risk = a partnership has no separate legal personality so the individual partners must enter into contracts with third parties in their own names and have unlimited liability against their personal assets if they default
• if a partnership is created inadvertently without a written agreement, default statutory provisions apply to determine the terms of the partnership which may be unfavourable especially in relation to profit and loss sharing
• financing is done by partners personally injecting capital or borrowing securing personal assets - may be difficult to borrow money as securities they can give are limited (e.g., no floating charge)

Question 5

what is the relationship between the partners themselves? what does this entail? (4)

Answer 5

Partners owe a fiduciary duty to each other.

This means they:

• owe an overriding duty of good faith
• must make honest and full disclosures
• cannot make unauthorised personal profits
• must avoid conflicts of interest

Question 6

what are the partners’ liability in contract between each other?

Answer 6

partners are JOINTLY liable for contractual obligations incurred while they are partner

this means that all partners collectively are liable to 100% of the obligations and creditors must claim against all partners

“Together we are jointly liable for 100% of the liability”

Question 7

what are the partners’ liability in tort between each other?

Answer 7

partners are JOINTLY AND SEVERALLY liable in tort

this means creditors can choose who to go after for the full amount and that partner can later recover from the other partners

“Together we are jointly liable for 100% of the liability, AND each person individually is liable for 100%”

Question 8

Will a new partner be liable for debts incurred before they joined the partnership?

Answer 8

not automatically - unless they agreed otherwise

Question 9

when will retired partners be liable for partnership debts?

Answer 9

partners who have left the firm will still be liable after they retire in respect of debts incurred by the partnership whilst they were a partner

Question 10

how can a retired partner be relieved from liability for obligations and debts incurred while they were partner?

Answer 10

that partner can novate the contracts they were party to with the consent of the other party

Question 11

when will a former partner be liable for partnership obligations and debts incurred after they left? how can the former partner prevent this from happening?

Answer 11

If, from the perspective of a third party, that person is an apparent partner of the firm = the third party can treat all apparent partners as jointly liable for the debt

this is unless the third party is notified that the partner left by:

• actual notice = for those who had actual dealings with the partner before departure
• constructive notice by publication in the London Gazette = for those did not have actual dealings with the partner before departure

but note: if the third party did not know this person to be a partner before they left, the partner will not be liable

Question 12

when will a non-partner be liable for partnership debts?

Answer 12

if a person held themselves out as a partner or knowingly allowed themselves to be held out as such

Question 13

what 3 requirements must be present for a person to have been ‘held out’ as partner - for a non-partner to be personally liable for partnership debts?

Answer 13

A non-parter will be personally liable for partnership debts if they held themselves out as partner - this requires:

1. partner made a representation to a third party that they are a partner (or allowed one to be made)
2. the third party relied on this representation (e.g., by supplying goods/services to the firm)
3. the third party believed in the representation

this is only to estalish non-partner liablity - to establish the liability of the firm, apply the common law principles of agency

Question 14

if an individual (partner or not) purported to bind the firm but did not have authority to do so, and the other partners are happy with their act, what can be done?

Answer 14

partners can RATIFY the act and adopt the contract either expressly or impliedly by performing it

Question 15

when will a partner’s unauthorised acts (entering contracts on behalf of the firm) bind the firm so that the firm will be liable?

Answer 15

s5 PA

1. the act is for carrying business of the KIND carried out by the firm (is this the kind of contract that this kind of business would carry out?)
2. the act is for carrying on such a business in the USUAL WAY (is this the kind of contract that the partner acting alone would usually make on the firm’s behalf or one that the third party would expect a partner to enter into individually?

–> consider this from the third party’s point of view

OR can also bind the firm under the common law of agency (apparent authority - representation and firm holds parter out as having authority)

Question 16

when will a partner’s acts (entering contracts on behalf of the firm) NOT bind the firm so that the firm will not be liable (s5 PA)? (2)

Answer 16

(1) the third party actually knew the partner was not authorised to enter into the contract on behalf of the firm

or

(2) the third party did not know or believe the person was a partner

–> consider this from the third party’s point of view

Question 17

when will the acts of a non-partner bind the firm so that the firm is liable at common law?

Answer 17

• common law of agency = if they had APPARENT AUTHORITY at common law
• the firm will be the principal and the non-partner will be the agent
• note: this could also apply to partners purporting to bind the firm

Question 18

when will a person purporting to bind the firm have apparent authority, thus bind the firm under common law of agency??

Answer 18

• the firm represents or permits a representation to be made to a third party that a person has authority to bind the firm (AND the third party relies on this representation) = firm is bound
• this could be where a person is being held out as a partner

example:

• a person with the title of marketing manager has the apparent authority to bind the firm on marketing decisions
• an ex-partner using the firm’s old letterhead to enter contracts

Question 19

how can a partnership agreement be varied?

Answer 19

by unanimous consent of all parties (express or inferred by a course of dealing)

Question 20

if partners do not enter a formal written partnership agreement, what terms does the partnership operate on?

Answer 20

default provisions of the Partnership Act 1890

disadvantage: these are outdated provisions that do not reflect how modern business is conducted - which can be disadvantageous especially in relation to sharing profits and losses

Question 21

what are the common terms in a partnership agreement to include? (14)

Answer 21

1) commencement and duration

2) partnership name and place of business (must not contain ltd, plc, llp)

3) what is deemed partnership property and how partners own partnership property

4) profit and loss sharing ratio

5) drawings

6) salary

7) work input, roles, and limits on authority

8) decision making threshold

9) incoming partners

10) expelling partners

11) effect of a partner leaving

12) non-compete

13) distributing assets on winding up

14) restraint of trade clauses on outgoing partners

Question 22

when does a partnership commence?

Answer 22

a partnership commences when partners trade with a common view to make profit

Question 23

if an agreement specifies a commencement date but partners start trading before, what is the effect of this?
what is the consequence if partners continue to trade after a fixed term in the agreement expires?

Answer 23

• if they start trading before a specified commencement date, then default provisions of PA 1890 apply until the commencement date
• if they trade after the duration expires, partners are presumed to be partners on the same terms as before (under the agreement)

Question 24

why is it important to include a commencement and duration term in a partnership agreement?

Answer 24

important because partners will have the certainty of knowing when their rights and obligations commence (otherwise if they start trading before, default provisions will apply which may be disadvantageous)

Question 25

under default provisions, what is deemed as partnership property?

Answer 25

• all property brought into the partnership on account of the firm or for the purpose and in the course of business is partnership property
• all property bought with money belonging to the firm is deemed bought for the partnership unless contrary INTENTION is shown (subjective element to show intention)
• Whether or not an asset is partnership property is a question of fact, depending on the intentions of the partners at the time they acquire it.

Question 26

under default provisions, how do partners own partnership property?

Answer 26

• each partner is deemed to own a share in partnership property
• an individual partner does not have any right to a particular partnership asset

Question 27

why is it important to include a term for what is partnership property and how partnership property is shared?

Answer 27

important if a partner is using their own assets for partnership business these assets may be deemed partnership property

Question 28

under default provisions, how are capital, profits, and losses shared?

Answer 28

• partners are entitled to share equally in the capital and profits of the business and to contribute equally towards the losses of the business
• this is even where partners contributed to the capital unequally

Question 29

why is it important to include a profit and loss sharing ratio term in a partnership agreement

Answer 29

important if partners contributed unequally to the capital they will share equally in profits and losses unless agreed otherwise

Question 30

what are drawings? how are drawings shared under the default provisions? why is it important to include an express term regarding drawings?

Answer 30

• drawings are portions of money that partners may take out of the income profits
• default provisions = partners are entitled to share equally in income profits
• important to agree on drawings term to set a limit on each partner’s entitlement to drawings

Question 31

what is the default provision in relation to salary? why is it important to include a term in relation to salary?

Answer 31

• default term = partners are not entitled to a salary
• important to include a term because partners may want to receive a salary (not allowed under PA) in addition to drawings

Question 32

under default provisions, who can take part in the firm’s management? why would a term be agreed on and what would that term be?

Answer 32

• default provision = every partner can take part in management but are not required to do so
• term can be added to limit partner roles and authority = important because partners should agree on who is entitled to carry out what work for the partnership and bind it

Question 33

what is the default provision on decision making?

Answer 33

partnership decisions are decided by a majority

except for these decisions that require unanimity:

• changes to the nature of the partnership business
• introducing or removing a partner
• varying the rights and duties of the partners

Question 34

why would a partnership vary the default provision on decision making and what would they vary it to?

Answer 34

important because partners may want more decisions to be unanimously taken to protect their position (as default provision requires majority consent except for important matters)

Question 35

what is the default provision on how new partners can be added to the firm?

Answer 35

requires unanimous consent of all partners

Question 36

how can a partner be expelled under default provisions?

Answer 36

• unanimity is required - a partner cannot be expelled by majority vote unless all partners have previously agreed that a majority can do this
• this means it is effectively impossible to expel a partner without their agreement

Question 37

why would a term be included in a partnership agreement for expulsion of partners?

Answer 37

• include a term on the required consent threshold reducing it from unanimity = otherwise parters cannot be expelled without their own consent
• include a term stating the partnership will persist and will not be disolved after the parter is expelled

Question 38

under default provisions, what happens when a partner leaves the partnership?

Answer 38

• the partnership is dissolved automatically
• if the other partners continue trading, a new partnership will have formed on the same terms as before

Question 39

why would a term be included in a partnership agreement for when parters leave / retire from the firm? what would such a term contain? (3)

Answer 39

important as otherwise partnership will be dissolved - term should state:

• the partnership will continue as between the remaining partners
• details of how a partner can leave (which may include a provision in the event of death) or be expelled without the partnership being wound up
• a mechanism for the remaining partners to buy out a departing partner’s share and for calculation of the value of such share

Question 40

what are the default provisions on competing with the firm?

Answer 40

if a partner competes with the firm’s business without consent of other partners, they must account to the firm for all profits made by them in that business

Question 41

under default provisions, in the event of winding up, how are remaining assets distributed to partners?

Answer 41

• any assets left after winding up will be distributed so that each parter is paid back their original capital first
• then any surplus assets are shared equally (or under an agreed profit sharing ratio)

Question 42

what are some restraint of trade clauses for outgoing partners that can be agreed?

Answer 42

• non-compete clauses (establishing same business)
• non-solicit clauses (soliciting clients)
• non-dealing clauses (entering contracts with clients or employees)
• there are no default equivalent (except for non-compete) so it is important to agree on these
• they will only be enforceable if they are reasonable (duration, area, scope) and are necessary for the protection of a legitimate business interest of the partnership)

Question 43

what are the 4 ways a partnership can be dissolved?

Answer 43

(1) automatic dissolution if fixed term expires, venture completes, or a partner dies or is bankrupt

(2) dissolution by notice from any partner where the partnership has no fixed duration

(3) dissolution is business is unlawful

(4) dissolution by the court

Question 44

what can a partner demand when a partnership is dissolved?

Answer 44

a partner can demand that the assets of the business are realised (sold for cash)

Question 45

How is a partnership taxed?

Answer 45

there is tax transparency so HMRC will look through the partnership and tax each partner individually on:

1. income tax for their share of partnership profits (either equally if no agreement or based on a profit sharing ratio)
2. capital gains tax for their share of a chargeable gain when the partnership disposes of property (each partner is treated as owning a fractional share of the asset disposed, and their share is based on an agreed profit-sharing ratio or equally if there is no PSR)

Question 46

what tax documents and information does a partnership have to submit to HMRC?

Answer 46

Even though the partnership itself does not pay tax, the partnership must make a SINGLE TAX RETURN OF ITS PROFITS

partners also submit their individual tax returns

Question 47

what are the features of a sole trader, and what are the advantages / disadvantages? what is the tax treatment?

Answer 47

advantages:
- no set up costs = ST can start trading immediately
- no formal structure = ST has complete control over how to run the business
- no formalities or companies house filings
- complete privacy = no need for publicly filed accounts

disadvantages:
- Unlimited personal liability = ST’s personal assets are liable to be sold to meet business debts
- Not a separate legal entity – individual contracts personally with third parties
- financed by a personal capital injection by ST or a loan secured by ST’s personal assets

tax treatment = individual ST pays tax as an individual (income tax and CGT) on any gains or profit made by the business (as it is not a separate legal entity)