Embarking on a new business venture with a partner is an exciting time, filled with optimism, ambition, and a shared vision for the future. In the rush to launch, it is common for partners to focus on the operational aspects—developing products, finding customers, and building a brand. The legal framework of their relationship is often based on an informal understanding or a simple handshake. While this is built on trust, it represents a significant and often underestimated risk.
What happens when partners disagree on the direction of the business? What if one partner wants to leave, or tragically, passes away? What if one partner contributes significantly more time and money than the other? Without a formal agreement, these scenarios can quickly escalate from disagreements into costly, relationship-destroying legal disputes that can cripple the business.
This is where a Partnership Agreement becomes one of the most valuable documents a business can have. It is a bespoke, legally binding contract that acts as a comprehensive rulebook for the partnership, which is why a partnership agreement is vital. It defines the relationship between the partners and governs how the business will be managed, both day-to-day and during times of change or crisis. This guide provides an in-depth exploration of what a partnership is under UK law, the severe risks of not having a formal agreement, and the essential components that every robust Partnership Agreement should contain.
What is a Business Partnership?
To understand the necessity of a Partnership Agreement, one must first understand the legal nature of a partnership itself. In the UK, the primary legislation governing this area is the Partnership Act 1890. The Act defines a partnership as “the relation which subsists between persons carrying on a business in common with a view of profit.”
Crucially, a partnership can be formed verbally or even implied through actions. There is no legal requirement to have a written agreement to be considered a partnership in the eyes of the law. While this offers simplicity in setting up, it creates a landscape fraught with danger, because if there is no bespoke agreement in place, the partnership will be governed by the default provisions of the 1890 Act.
These default rules were written for a different era and are often completely unsuitable for modern businesses. They represent a one-size-fits-all solution that fails to account for the unique contributions, intentions, and complexities of any given partnership.
It is also important to distinguish between different partnership structures:
- General Partnership: This is the default structure, where two or more individuals are partners. Critically, partners have unlimited liability, meaning their personal assets are at risk to cover business debts. This article focuses primarily on this structure.
- Limited Partnership (LP): This involves at least one ‘general partner’ with unlimited liability and one or more ‘limited partners’ whose liability is limited to their investment, provided they do not participate in the management of the business.
- Limited Liability Partnership (LLP): This is a separate legal entity where the ‘members’ have limited liability, protecting their personal assets. LLPs are governed by their own legislation (the Limited Liability Partnerships Act 2000) and require an LLP Agreement, which serves a similar function to a Partnership Agreement.
Why Relying on the Partnership Act 1890 is a Major Risk
Operating a General Partnership without a bespoke agreement means you are automatically subject to the default rules of the Partnership Act 1890. Here are some of the most significant risks this creates.
Equal Profit Sharing, Regardless of Input
The 1890 Act dictates that all profits and losses must be shared equally among the partners. This applies irrespective of the amount of capital each partner invested, the number of hours they work, or the level of expertise they bring. This can quickly lead to resentment and disputes where one partner feels they are contributing disproportionately more than the others but is not being rewarded for their additional effort and investment.
Joint and Several Liability
This is one of the most critical aspects of a General Partnership. ‘Joint and several liability’ means that all partners are collectively responsible for the business’s debts, and each partner is also individually responsible for 100% of the business’s debts. For example, if the partnership has a debt of £100,000, a creditor can legally pursue any single partner for the full amount. This risk is amplified if a partner faces personal insolvency, as their personal creditors could potentially look to partnership assets.
Unanimous Consent for Major Decisions
The Act states that certain decisions, such as changing the nature of the business or introducing a new partner, require the unanimous consent of all partners. While this sounds democratic, in practice it can lead to complete deadlock. A single dissenting partner can halt progress and prevent the business from adapting or growing.
Automatic Dissolution upon a Partner’s Departure
This is a profound and often overlooked danger. Under the 1890 Act, the partnership is automatically dissolved if any partner dies, is declared bankrupt, or simply chooses to retire. This means the business technically ceases to exist. The assets must be valued and distributed, which can force the sale of the business, even if the remaining partners wish to continue.
No Power to Expel a Partner
Imagine a scenario where a partner is consistently failing to perform their duties or is actively harming the business. The Partnership Act 1890 provides no mechanism for the other partners to expel them. The only way to remove a partner against their will is to dissolve the entire partnership, a drastic and often ruinous step.
The Key Components of a Comprehensive Partnership Agreement
A professionally drafted Partnership Agreement allows you to override the unsuitable default provisions of the 1890 Act and create a bespoke constitution for your business. It anticipates future challenges and provides a clear roadmap for handling them. Here are the key clauses it should contain.
The Basics: Name, Purpose, and Duration
This section establishes the fundamental identity of the partnership, including its name, place of business, purpose, and intended duration.
Capital Contributions
This clause should clearly state the amount of capital each partner will contribute and how future contributions will be handled.
Profit, Loss, and Drawings
This clause replaces the default rule of equal sharing, allowing you to define how profits, losses, and regular drawings (income) are allocated.
Roles, Responsibilities, and Authority
This section should define each partner’s role and duties and set clear limits on their authority to act on behalf of the business.
Decision-Making and Management
This clause can specify which decisions require a simple majority versus a higher threshold, such as unanimous consent, preventing the deadlocks that can occur under the default rules.
Partner Departures (Retirement, Resignation, and Expulsion)
A well-drafted agreement provides clear exit strategies, which form a key part of any family business’s succession plan. This is especially complex where partners are also a cohabiting couple, as business separation can become entangled with cohabitation breakdown and property disputes.
Death or Incapacity of a Partner
Instead of automatic dissolution, the agreement can ensure business continuity. This clause should work in tandem with each partner’s personal estate planning, and our solicitors can provide expert advice on drafting wills to ensure your business interests are handled according to your wishes.
Dissolution of the Partnership
This clause sets out an orderly procedure for winding up the business if the partners agree to go their separate ways, detailing how assets will be valued and distributed.
Dispute Resolution
Even with the best agreement, disagreements can occur. This clause mandates a specific process for resolving them, helping partners navigate all forms of dispute resolution. As a breach of the agreement is a form of contractual dispute, having a clear process can save an enormous amount of time, money, and stress.
Partnership Agreements vs. Other Business Structures
It is useful to understand how a partnership agreement fits within the broader context of business structures. Just as a limited company relies on a shareholders’ agreement for start-up businesses, a partnership relies on its agreement to govern the relationship between the owners. While a partnership is simple to set up, the unlimited liability is a major drawback that a limited company structure avoids. An LLP agreement is similar in function to a partnership agreement but for a different legal structure that offers its members limited liability.
Conclusion: Your Partnership’s Most Valuable Insurance Policy
A Partnership Agreement should not be viewed as a sign of mistrust between partners. On the contrary, it is a hallmark of professionalism, foresight, and mutual respect. It is a document born out of optimism—an acknowledgment that the business will become valuable enough to be worth protecting.
By openly discussing and agreeing on the difficult “what if” scenarios from the outset, partners can prevent future misunderstandings and protect their personal and professional relationships. It acts as a private, bespoke legal framework that insulates your business from the outdated and often unsuitable default provisions of the 1890 Act.
In essence, a comprehensive Partnership Agreement is one of the best and most cost-effective insurance policies you can have for the long-term health and stability of your business. If you are starting a business with a partner, taking on board some legal tips to set up a business and seeking expert advice to draft an agreement tailored to your specific circumstances is not just a recommendation; it is an absolute necessity.