Forming A Partnership TIM TIERNEY
Tierney Law Barristers & Solicitors 8/16 Main Road HUONVILLE TAS 7109 Phone: (03) 6264 2967 Fax:(03) 6264 2688
What is a Partnership?
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Do I need a Written Agreement?
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Will a Standard Agreement be Sufficient?
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Who Controls the Business?
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Who Is Responsible For A Partnership?
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Can Partners Limit Their Responsibility?
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What Books Need To Be Kept?
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How Long Does a Partnership Last?
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Can a Partner Sell A Share of the Partnership?
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Do You Really Want A Partnership?
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What Are The Advantages Of Partnerships?
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What Are The Disadvantages Of Partnerships?
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How is a partnership Taxed?
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What Will A Partnership Agreement Cost?
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Who Will Be Your Partners?
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Do We Each Need A Lawyer?
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What Is The Business?
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When And For How Long?
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How do the partners get out?
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What Is In A Name?
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Which Bank?
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Who Will Be The Accountants?
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Where Do They Get The Money?
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Can One Partner get a Salary?
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What is Your Level of Commitment?
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What If A Partner Retires?
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What If A Partner Dies?
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Options?
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Can Partners Leave And Set Up In Opposition?
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What If Partners Do Not Agree?
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How can I safeguard my partnership?
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What is a Partnership? A partnership is a relationship where a business is carried on for profit by more than one person. A partnership has no existence separate from the partners. Unlike a company it is not a separate person. Generally the number of partners cannot exceed twenty. Partnerships are broad ranging longstanding relationships. They are difficult to manage and difficult to record legally. You need to be careful.
Do I need a Written Agreement? A verbal agreement can form a partnership. It would be unwise to start a business venture without the partnership agreement being reduced to writing. A written agreement allows you to properly document the terms of your partnership to suit the requirements and wishes of the partners. Friction between the partners can destroy a business. A written agreement lessens the chance of such disagreements. A written agreement provides a mechanism for resolving such disagreements. The process of determining what will be in the written agreement can determine issues that otherwise would cause a dispute. It is much easier to agree on an issue before the problem arises. Without a partnership agreement, a partner can bring the partnership and the business to an immediate end at any time. A partnership agreement can provide a sound system to regulate disputes and departures from the business. Consider the following scenarios: ♦ I shall be retiring at the end of the year. Can I still be sued as a partner after that? ♦ One of my partners is drinking a lot and has already upset some of our customers. What can we do? ♦ My senior partner has committed the firm to the purchase of very expensive equipment without consulting other partners. What can we do? ♦ I am unhappy in my firm because I see opportunities for new business but my partners will not support me. If I leave and set up on my own, will there be any problems? ♦ A partner is using the firm's client list to market a new business interest of his own. What is the legal position? ♦ A partner is showing signs of dementia (forgetfulness, loss of concentration and irritability). What can we do?
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♦ A partner is spending more and more time on activities not connected with the firm, but for which he receives a fee. Should he account to the firm for these earnings? ♦ I joined a firm, bringing with me profitable contacts, under an arrangement based upon profit projections but without seeing the accounts. I have since discovered that I was misled and profits will be much lower. My partners will not give me straight answers. What can I do? These, and many other potential problems, could be a disaster. If partners do not have the protection of a written agreement the answers may be unclear and unsatisfactory.
Will a Standard Agreement be Sufficient? The written partnership is the primary document that establishes the framework of your relationship. It is important you understand it. It is important to precisely tailor the agreement to your requirements. Usually this first draft of the partnership agreement is based on the solicitor’s standard trading partnership. This usually assumes a flexible arrangement with broad powers in favor of individual partners. It is possible to restrict the powers of a partner to act on behalf of the others. Find your balance. If the partnership agreement is too restrictive operation of the partnership may be clumsy. Many commercial and legal documents are standard documents that, in substance, put into effect the standard transaction. Bank Mortgages, for instance, are not subject to negotiation and are not dedicated to each incident of their use. To that extent, it is not important that they be dedicated to your personal circumstances. By contrast, your partnership agreement needs to, not only be correct, but also suit your circumstances. You need to consider and understand each paragraph.
Who Controls the Business? The partnership agreement should specify who will control and manage the business of the partnership. Without an agreement, all general partners have equal control and equal management rights over the business. This means that all the partners must consent and agree to partnership decisions. It is important to note, however, that any partner can bind the partnership and the individual partners to contracts or legal obligations, even without the approval of the other partners.
Who Is Responsible For A Partnership? All partners will be jointly and severally bound by the debts of the partnership. Each partner has a right to claim against the other partners their proportionate share of debts that have been properly incurred. A partner who wrongfully incurs a debt is responsible for that debt to the other partners. All the partners are liable together and each general partner is individually liable for all the obligations of the partnership. This Page 5
means that a creditor of the partnership could require you individually to pay all the money the creditor is owed. Your partners should then reimburse you for their share of the debt or loss. Before you decide to join a general partnership, determine whether your partners can financially afford to share the losses of the partnership. If you are the only partner with any assets or money, the creditors of the partnership can require you to pay them, and you may be unable to get reimbursement from your partners.
Can Partners Limit Their Responsibility? A limited partnership is a special type of partnership where some partners have limited responsibility. A limited partnership consists of one or more general partners (i.e., those who are generally liable for the business) and one or more limited partners (i.e., those who have limited liability). Limited partners do not have personal liability for the business of the partnership. Limited partners are at risk only to the extent of their previously agreed upon contributions to the partnership. In a limited partnership, the general partners handle the management and control of the business. The controlling legislation restricts the types of control and management the limited partners can undertake without jeopardising the limited partnership’s status. If the statutory requirements are not followed, a limited partnership will be treated as a general partnership and the limitations on the responsibility of limited partners is lost. There are special taxation arrangements for limited partnerships. It is vital that you consult with a lawyer and accountant experienced in limited partnerships before creating a limited partnership. Limited partnerships are rare.
What Books Need To Be Kept? The partnership should keep separate bank accounts and financial records for the business so the partners know whether there are profits and losses, and how much of either they receive. Discuss all this at the start with your accountant.
How Long Does a Partnership Last? A partnership exists as long as the partners agree it will and as long as all the general partners remain in the partnership. Unless otherwise agreed, the partnership dissolves if a general partner dies or leaves the partnership. Then, the assets of the partnership must be sold or distributed to pay first the creditors of the partnership and lastly the partners. The partnership agreement should provide for the continuation of the business by the remaining partners. This avoids a forced sale of the business upon the withdrawal of a general partner. A general partner who leaves a partnership, can have an accounting that will determine the value of shares of the assets and profits of the partnership. The agreement should also cover payment for a partner's share of the partnership when he or she leaves or dies. Page
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Can a Partner Sell A Share of the Partnership? The partnership agreement should state whether a partner can sell his or her partnership share. Even if a partner does transfer a share of the partnership, he or she will remain personally liable for the business losses incurred before the sale of that interest.
Do You Really Want A Partnership? Would it be better if only one of the parties was responsible for the venture? Other participants could be employees or lenders. This could involve profit sharing. The big question is who owns the business. This person is in charge to make the decisions and is responsible for the business. With a risky business perhaps only one person should have their head on the chopping block? A company is an alternative to the complete responsibility under a partnership. A company may allow you to limit your liability to the extent of the capital introduced to the venture and any personal guarantees given. The disadvantages of a company include extra expense and the restrictions and administrative burdens of companies. Usually used in conjunction with a company, a trust can allow income splitting more broadly and with greater flexibility. A booklet with a comparative review of business structures is available from Tierney Law.
What Are The Advantages Of Partnerships? A Partnership: ♦ Is a very flexible form of business. ♦ Permits ownership by more than one individual. ♦ Allows some income splitting ♦ Has few legal formalities for its maintenance. ♦ Is cheap and simple to establish and run.
What Are The Disadvantages Of Partnerships? In a partnership: ♦ Decision-making and disagreements can be difficult. ♦ Partners have unlimited personal liability for business losses. ♦ Each partner is legally responsible for the business acts of each other partner. ♦ Dealing with a part interest in the business is difficult without consent of all partners.
How is a partnership Taxed? Partners lodge partnership tax returns showing their common trading but the profit or loss of the partnership is distributed in that return to the individual partners. Those distributions are then assessable as Page
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part of the individual tax returns. The partners thus pay the tax separately rather than jointly as a partnership.
What Will A Partnership Agreement Cost? Our fee on a typical partnership agreement is $400.00 plus $40.00 GST but more complicated partnerships agreements may cost more if they take an unusual amount of time. There is no longer any stamp duty on the partnership agreement.
Who Will Be Your Partners? A partnership is like a marriage. Both need deep mutual trust, respect and the ability to work together to resolve a dispute. A good partnership like a good marriage thrives on complimentary and differing skills and personalities. Like a bad marriage a bad partnership is hell. Friendship can be the basis of a good partnership. Some times friendships do not survive a money-based relationship. A social friendship is a very different relationship to a working business partnership relationship. Friends must adjust to the changes a business partnership makes to their relationship. Think carefully about whether participants should be partners or employees. Should the spouses be involved and how? To get income splitting benefits non-active partners do not have to participate as full partners. What happens if one of the couples separates? For the good of the partnership, can you pre-agree that one spouse has the right to buy out the other and on what terms? The Family Court will make its own decisions if the spouses do not agree but will respect genuine business agreements particularly if they involve third parties. The partnership agreement may protect the business as well as the separating spouses from a destructive dispute or an inconvenient drain on capital.
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Partnership must: ♦ be honest just and faithful to the other partners. ♦ always give to the other partners full information and truthful explanations of all matters relating to the affairs of the partnership. ♦ afford every assistance in that partner’s power in carrying on the business for their mutual advantage. ♦ preserve confidence in the partnership; ♦ avoid conflicts of interest; ♦ avoid profiting personally from partnership opportunities and information; and ♦ account for benefits obtained in breach of those duties to the extent they relate to the partnership; You cannot rely on the law to enforce obligations like these. They must live in the heart of the partners. If you do not feel that commitment to or from your partners, do not go any further. Without that honest pursuit of the common rather than individual good, a partnership is doomed.
Do We Each Need A Lawyer? Partners should be separately represented in the preparation of a business partnership. Particularly if the parties are making different contributions or have different circumstances, independent legal advice is wise.
What Is The Business? The partnership agreement will specify the nature of the business. Treat this question as part of your business planning. Agree on the business objectives and how you will achieve them. If one partner plans a bed and breakfast and the other a four star hotel, they must do more than agree they are in the accommodation business. Consider not only where you are going but also how you will get there. The workaholic and the laid back will be a bad combination if each cannot accept the other. Sometimes business milestones are preconditions for further action such as adding capital or undertaking commitments. Do any such matters need to be specified in the partnership agreement? It is easy to say that you can’t base a good partnership on a bad business. You need to safeguard your business by having a clearly defined business plan that all partners agree on. There really is no substitute for a written business plan. Even a written list of planned action and objectives is better than nothing. Unless you know where you are heading and agree on it, you are not likely to get there.
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When And For How Long? When do the parties intend to start? When will the first common action take place? Is the venture of limited duration? The agreement should specify the decisions reached.
How do the partners get out? Partners need to have an exit strategy. Nothing lasts forever. What happens if someone wants to retire? How do the partners get out of the business? One possible exit strategy is the partners sell either the whole of the business or a share in the partnership. If this is to be done you need to look ahead as to whether the business will be attractive to purchase and how this will be managed. It may be necessary to have in place insurance to provide funds to cover one of the partners becoming sick or dying. Sometimes parties buy insurance policies to also recover retirement.
What Is In A Name? What will be the firm name? Is one party to have preferential rights to the name on winding up the partnership? Mr. Snooks the plumber for twenty years will be disappointed if after a two year partnership he loses his rights to the much loved name “Snooks No Drips Plumbing”. A partnership may operate under the names of the partners without registering any particular name. If you wish to use a name other than your own, or only one of your names, you must register the business name with the State Government. It is necessary to notify the registry of changes to persons operating under a registered business name. Registration of a business name merely gives a licence to use a name other than your own. It does not affect your legal responsibilities for actions of the partnership or its debts. It does not give the limited liability that the incorporation of a company provides. The registered business name regime is essentially a tracking system to identify the legal person behind the trading name. It is not an approval system. Like the registration of a company name, a registered business name does not confer ownership or enforceable rights upon the person registered. The business name licence is statewide only. If there is to be trading in several States, you must register in each State. A person can acquire rights to a trading name just by using it. If a company, business or other name has a sufficient reputation attaching to it, the owner of that name may be able to prevent another Page 10
person using a similar name because the use is likely to mislead or damage the business of the person with the existing reputation. These rights are often called “common law trademarks” .There is no register of these common law rights that can be checked before starting to use a new name. Knowledge of the names and marks used in the relevant industry is extremely valuable. The Fair Trading Act and the Trade Practices Act outlaw misleading and deceptive conduct. This is a further and broader basis upon which a person can prevent another person entering into a market with a similar name or mark. Registered trademarks are a source of extremely powerful rights. The Trademarks Act has a register of trademarks available to the public. Where the name involves elements of design or shape, copyright and registered designs might also protect a name. Before using a name proper searches should be undertaken to see whether it is available. These may include business name and securities commission searches, trademark register searches and more general reviews of the market, including for instance, search of the electronic databases of Yellow Pages and the Internet more generally.
Which Bank? The Bankers of the partnership are usually pre-agreed subject to later variation by agreement. The parties usually decide what signatories are needed for cheques in the name of the firm.
Who Will Be The Accountants? The Accountants of the partnership are usually pre-agreed subject to later variation by agreement. The partnership agreement often gives the accountant some arbitration role, so selection can be important. Usually for instance, the agreement provides the partners shall be bound by the annual accounts as drawn by the accountants unless some manifest error shall be discovered within three months.
Where Do They Get The Money? It is important to specify what capital is being contributed by the partners in what shares, including the obligations to commit capital in the future. It is sound to pre-agree some policy for the distribution of profits, not just the basics of the division into shares but also when drawings will be made. Usually profit and cash flow are difficult to predict and the cause of most business failure. Agree on plans and policies.
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If one partner contributes more capital than the other, the parties may agree that partner should get a preferential return on a similar basis. Consider a policy on the return on loans made by partners to the firm.
Can One Partner get a Salary? By agreement the parties can appoint salaried partners who can draw a regular amount by way of salary. Should such salary be in addition to that partner’s drawings and counted as an operating expense of the business to be included before the division of profits? This may be fair IF there is an unequal contribution of labour.
What is Your Level of Commitment? Will all parties work similar hours? Is weekend work valued differently than weekday work? Is one partner to receive greater reward than the other for some greater expertise skill or training? Must each partner diligently attend to the business? What holidays will be taken and on what basis? What sick leave entitlements do the partners have? Is income insurance necessary? May a partner carry on any other business? What are the employment policies? What If A Partner Defaults? Usually the agreement will say that the innocent partners can expel a guilty partner who shall: Commit any substantial breach. Commit an act of bankruptcy. Become physically or mentally unfit to attend to the business. Be convicted of any criminal offence. Do or suffer any act that would be a ground for the dissolution of the partnership by the Court. The partnership agreement will usually specify the terms upon which the expulsion shall take place.
What If A Partner Retires? Can any of the partners dissolve the partnership and how?
What If A Partner Dies? What if a partner dies during the continuance of the partnership? Does his estate have the right to sell his interest? Does the interest have a fixed price? Can members of his family join the partnership?
Options? If one partner leaves, what happens to his share? Usually a continuing partner has the option to buy that partner’s share in the Page 12
capital and assets of the business on agreed terms. Typically if the option to purchase is not exercised, the departing partner may sell his interest in the partnership to such person as approved by the continuing partners or may terminate the partnership.
Can Partners Leave And Set Up In Opposition? Many partnerships provide that any partner expelled or retiring cannot join a competing business to the partnership. If this appropriate the partners need to consider; • What would be the terms? • How long would the restriction last? • What is the definition of a competing business?
What If Partners Do Not Agree? Disputes are inevitable. How will you minimise them? How will you deal with them? What decision-making processes can you agree? Does one partner have more say than others? Does majority rule? The start of the venture is a good time to consider decision-making policies for your business. Put in place some agreed guidelines for future decision-making including the limits of individual authorities and the timetable for regular meetings. A partnership is a combination of a personal and business relationship. You need to manage both aspects of the relationship. Sometimes you need to put aside personal tensions to keep the business relationship working. On other times you need to be careful to make sure that disagreements over the business do not cause a breakdown of your personal relationship. Because of the personal element of the relationship, partnership disputes can be difficult to resolve, particularly by court proceedings. Often mediation is a valuable tool. Baker Tierney & Wilson has another booklet on mediation if you need more information in that area.
How can I safeguard my partnership? When you form your partnership take care to: • Prepare, agree and record a detailed business plan. • Make sure you are founding a good partnership on a good business. • Take professional advice on preparing a proper partnership agreement. • Make sure all partners understand their roles and responsibilities. • Determine issues on the division of responsibility, decision-making and conflict resolution. • Work out at the beginning, a framework to resolve problems that may arise in the future. • Provide for possible breakdowns so the business can survive if one of the partners choose or is forced to leave. Page 13
• Establish a good working relationship on a personal level between the partners. While the partnership is continuing be careful to: • • • • •
Watch out for early warning signs of future conflict. Resolve problems before they get too big. Don’t let resentment simmer. Keep flexible. Keep taking professional advice as necessary.
If the partnership is about to explode take care to: • Seek mediation before you rush off to the courts. • Take accounting and legal advice early and often. • Keep an eye on the separate values of the business relationship and the personal relationship. Don’t let one sour the other.
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