When you operate your business as a partnership, you share ownership with the other partners. You run the business together, making key decisions and sharing the profits and losses. Business partnerships offer several key benefits. Unlike sole trader arrangements, they allow you to share liability and draw on your partners’ support, experience and financial resources. They are straightforward to establish (and will sometimes be implied) and are not subject to the levels of scrutiny and filing requirements applicable to limited companies.
There are other types of business entities known as ‘limited partnerships’ and ‘limited liability partnerships’, which differ from a general business partnership in numerous material respects. These entities are outside the scope of this article, in which our business dispute solicitors focus on the law relating to business partnership disputes that arise in general partnership situations.
- The Liability of Partners
- Common sources of conflict in a partnership
- Do you have a Partnership Agreement?
- Has there been a breach of the Partnership Agreement?
- What evidence do you need to bring a claim?
- Process for bringing a claim
- How do you resolve a partnership dispute without going to court?
- Partnership dissolution
The Liability of Partners
Unlike a limited company, a general partnership is not a legal entity in its own right. The ultimate owners of a company are generally shielded from having to personally meet the debts and obligations of the company, whereas the personal liability of partners is potentially unlimited.
The partners’ liability for the partnership’s contractual debts is joint, meaning that the partnership as a whole is liable for any debt, even if only one partner was responsible for incurring it. Where a partner has acted improperly, all partners are ‘jointly and severally’ liable for the wrongful acts or omissions, to the extent that those acts were carried out in the ordinary course of the partnership’s business. For example, if a rogue partner misappropriates client funds, the client may seek recourse against all or any one of the partners, whether or not that partner was involved in the wrongdoing.
Your liability as a partner does not end when you retire, and you remain liable for debts and wrongdoings which accrued or occurred beforehand. Your liability under ongoing contracts similarly continues. So, if you are a party to the lease for your business premises, for example, your retirement does not terminate your liability under the lease.
Importantly, those entering a partnership are not liable for any debts or obligations which accrued or occurred before they joined, although new partners often agree to assume liability for the partnership’s existing liabilities.
Common sources of conflict in a partnership
As with any form of business arrangement involving two or more individuals acting together, conflicts often arise in general partnerships.
Common sources of conflict include –
- Breach of fiduciary duties. The success of a partnership relies on the partners working together for the benefit of the partnership as a whole as opposed to progressing their own personal interests. Partners are, by law, obliged to act in good faith towards one another and are subject to numerous duties relating to honesty and integrity, known as ‘fiduciary duties’. Those duties include that the partners will act honestly, not make an unauthorised personal profit and avoid putting themselves in a position where the interests of the partnership conflict with their own. Disputes often arise when a partner breaches a fiduciary duty. Common examples of such breaches include when a partner diverts a business opportunity away from the partnership for their own gain or conceals important information relating to partnership business, which results in the partnership suffering financial loss.
- Disagreement over the strategic direction of a business. Partners often have different skill sets and strengths. One partner may possess technical expertise which enables the business to develop cutting-edge products, whereas another may be a ‘people person’, adept at sales and marketing. When these individuals work together effectively, their combined strengths can contribute significantly to the partnership’s success. Sometimes, though, they can give rise to competing priorities. Disagreements can arise between the partners over matters relating to the strategic direction of the partnership and the level of investment which should be given to different elements of the business.
- A partner is not pulling their weight. We have seen that partners are subject to fiduciary duties imposed by law and how conflicts can stem from a breach of those duties. Conflicts can also arise when a partner simply isn’t pulling their weight. Their conduct may not amount to a breach of fiduciary duty since there may be no dishonesty or concealment but can nonetheless cause significant issues for the other partners.
- A poorly drafted partnership agreement. A properly drafted Partnership Agreement comprehensively documents the partners’ intentions and leaves little room for disagreement. Matters regularly dealt with in a Partnership Agreement include how profits and losses should be distributed, the partners’ rights and responsibilities and exit rights. If a Partnership Agreement is poorly drafted, disputes can arise over the true meaning and interpretation of its terms and the nature and extent of the partners’ rights and responsibilities.
Do you have a Partnership Agreement?
A partnership may be implied in any situation where two or more people carry on business with a view to profit. It is, however, advisable to enter into a formal Partnership Agreement. A watertight Partnership Agreement will ensure that all partners know where they stand and are clear about their rights and responsibilities. A Partnership Agreement is also crucial to address issues such as retirement rights since, without one, the entire partnership must be dissolved if a partner wants to retire.
Many well-drafted Partnership Agreements will contain a dispute resolution clause. So, if you have a Partnership Agreement in place, this will be your first port of call in the event of a partnership dispute.
The dispute resolution clause may require the parties to seek a resolution to any issue through alternative dispute resolution methods such as Mediation. The clause may also stipulate whether proceedings need to be brought by way of arbitration or litigation. It is crucial to seek legal advice from a business dispute solicitor when considering taking action against a partner to ensure you adhere to the provisions of your Partnership Agreement, including any notice requirements.
Your Partnership Agreement may contain provisions allowing for the buyout of a partner in specific situations. Buyouts can be a convenient way for partners to resolve disputes with minimal impact on the partnership business.
If you do not have a Partnership Agreement, the business will be governed by the Partnership Act 1890. The Act’s provisions may come as a surprise and often do not deal with issues how the partners would like, or at all. There is no right to expel a partner under the Act, and if a partner wants to leave or retire, or if the relationship between the partners becomes untenable, the only option is to dissolve the partnership.
Has there been a breach of the Partnership Agreement?
Properly drafted Partnership Agreements will contain provisions detailing the obligations and responsibilities of the partners, which usually include duties akin to fiduciary duties. If a partner fails to comply with their obligations under the Agreement, the other partners may be able to take action against them for breach of the Partnership Agreement.
What evidence do you need to bring a claim?
When bringing a claim for breach of your Partnership Agreement, the most important piece of evidence will be the Agreement itself. The Agreement should prove that a legal partnership exists and detail the obligations agreed upon between the parties. Those obligations will apply alongside the general fiduciary duties imposed by law.
You will need to prove that the partner in question breached either a contractual obligation, fiduciary duty or both, and show that the breach caused you financial loss.
The evidence required to support your case will depend on the nature of the breach. It may include relevant correspondence between the partners and third parties, internal documentation such as memos and minutes of partnership meetings and financial documentation detailing your losses. It is crucial to retain all evidence which may assist your claim.
Process for bringing a claim
Your business dispute solicitor will begin by sending a detailed ‘letter of claim’ to the partner in breach. The letter will detail the circumstances of the breach and set out the action required to resolve it. It will inform the other party that if they fail to comply with your demands, you will consider legal action compelling them to do so.
If the matter proves incapable of resolution at this early stage, your next step is to issue proceedings at Court, seeking potential remedies. The remedies may include damages, an injunction or dissolution of the partnership. If the other party fails to respond to the claim, you can apply for Judgment by Default whereby the Court may automatically grant the relief sought. If your claim is defended, the Court will set a timetable of the steps the parties must take ahead of the trial. Those steps may include disclosing relevant documents and exchanging witness evidence.
Your business dispute solicitor will guide you through the litigation process and ensure all steps are completed by the Court’s deadlines.
How do you resolve a partnership dispute without going to court?
Your Partnership Agreement may contain clauses detailing the remedies applicable to specific breaches. It may, for example, include an ‘Expulsion Clause’ allowing a majority of partners to expel another if they have ‘materially breached’ the agreement. A material breach is, generally speaking, one which is so severe that the other partners feel unable to continue in business with the partner in breach.
If your Partnership Agreement contains a Dispute Resolution clause, your solicitor will advise on the contractual steps you must take in the event of a dispute, which may include attempting to resolve the issue through alternative dispute resolution (ADR) methods before taking legal action. If your Agreement is silent on the subject, your solicitor will still consider the suitability of ADR methods, such as mediation, to your case. ADR can be an invaluable tool in avoiding the time and cost of legal proceedings, and parties who unreasonably refuse to engage in ADR may be penalised by the Court on costs.
The law applies specific remedies to particular types of contractual breaches, which may include damages and injunctive relief. ADR allows parties to settle their dispute between them on terms acceptable to all involved. Those terms can be very wide-reaching, and whilst the applicable legal remedies will often be used as a starting point, they do not bind the parties.
Sometimes, the relationship between the partners deteriorates to such an extent that the only viable option is for the partnership to be dissolved and its business wound up.
There are numerous mechanisms through which a partnership may be dissolved. There may be a clause in your Partnership Agreement detailing the circumstances which can trigger dissolution –a majority agreement, for example. The Partnership Act allows dissolution through unanimous agreement of the partners, as well as other situations including when a partner wilfully or persistently breaches the Partnership Agreement.
Whilst business partnerships offer valuable benefits to those in business, the nature of a partnership and, in particular, the partners’ unlimited liability means that disputes often arise. The law governing business partnership disputes is complex and requires not only a thorough understanding of contract law and disputes but also the peculiarities of a general partnership situation and the impact of the Partnership Act. Accordingly, you should seek specialist legal advice from a business dispute solicitor as soon as you become aware of a potential dispute to ensure you are properly protected and avoid inadvertently taking any action which could jeopardise your position.