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The Accidental Partnership

11 August 2021 by ac Leave a Comment

Two friends decide that they will start a business together. They don’t form a company for that business but just decide to see “how it goes”. After all, it’s early days.

At first the business does well. It grows and profitability is good. Then the business hits a rocky patch – perhaps fuelled by a breakdown in relations between the (now “former”) friends. As tensions mount the business begins to slide into the red and an argument breaks out over who owns what in the business – for instance, its name. One of the friends takes advice and learns that not only that he has legally been in partnership with the other since they started the business but that he has unlimited personal liability for all of its debts, in the event that it goes to the wall. How did this state of affairs come about?

Partnership is defined in the Partnership Act 1890 (“the Act”) as being “the relationship which subsists between persons carrying on a business in common with a view of profit”. That means that whenever two individuals get together to start or to run a business they may become partners – automatically by operation of the Act. There are other factors that the courts will consider in deciding whether a partnership has arisen, but essentially it can be as easy at that. And there are many consequences that flow from being in partnership. Each partner has joint and a several liability for all of the debts and financial obligations of the partnership. This means that they are each personally responsible for the debts of the business. So if you do not know your partner very well and if he or she subsequently runs amok, incurring huge expenses for the business, you could find yourself liable for them – and not just half of the expenses, but all of them. It will be the decision of the creditor as to which of the partners he wishes to sue for the sum that it is owed. Alternatively, the creditor may decide to sue all of the partners.

The Act also creates a statutory framework for the operation of a partnership, in the absence of any written agreement to the contrary. It is open to the parties to agree the terms on which they are in partnership and, if they wish, they can displace that statutory framework by doing so. Although it is not necessary that the terms should be recorded in writing, if any dispute arises this is naturally much more helpful. In the absence of any agreement (whether written or oral) there are a number of assumptions about ownership of the partnership’s assets. For instance, even though contributions to the partnership’s assets may have been unequal (perhaps with one partner investing more capital and the other spending more time on the business) the court is likely to begin its process of dividing up a partnership which is to be dissolved on the basis that it should be split between the partners equally. For that reason alone it is essential to record the terms on which you wish to enter into partnership with someone else.

A partnership in which there is no written or other agreement as to the terms of the relationship is known as a partnership “at will” and can be terminated by any of the partners simply by the giving of notice of termination. No notice period is required. Once the partnership has been terminated, all of the partners are under a continuing duty to collect in the business’s assets and realise the highest possible value for them with a view to paying off creditors and then, finally, make a distribution of any surplus to the partners. Conversely, if there is any loss, after all the assets have been realised, then that loss is to be shared between the partners. So bear in mind that even if you want to bring a partnership to an end, immediately, you may need to continue running the partnership for a further period simply to work through business in the pipeline, in order to avoid heavy losses.

So if you are thinking about starting a new business, consider whether you want to do so in a partnership or whether your business would be better suited to a company which, at the very least, has the potential to confer limited liability on those running it – or perhaps even consider a Limited Liability Partnership, a partnership, but with some of the protection afforded by a company. If you do want to go into partnership, or any other form of business, get an agreement in place, at an early stage, to set out the parties’ respective obligations. You will thank yourself later for doing so.

Goodbye To Good Faith

11 August 2021 by ac Leave a Comment

Picture the scene; a solicitor is meeting a number of partners from another firm – an LLP, whose members prefer to use the more traditional and easily recognised honorific of “partner”. He is thinking about joining their number. The solicitor asks whether the partnership is a happy one and about the culture of the firm. The question is almost de rigueur – as is the answer; “We have our differences but we are very collegiate.”

Wind the clock forward; it is two years later and things have not worked out for our solicitor – he has just been handed a notice requiring him to retire as a partner. He is, in fact, being expelled. He never saw this coming. He had never been told that his position was at risk. He was even performing better than some of his partners who had been with the firm for much longer – but they are not being given “the chop”. Everything leading up to his expulsion took place behind closed doors. Things don’t feel very collegiate to him.

In fact our unfortunate partner may have opened the door to treatment of this kind when he signed up to the LLP’s Members’ Agreement. His partners may be able to argue that, under the Members’ Agreement, they are acting within their rights.

Everyone is familiar with the fact that LLP’s offer the opportunity to limit a partner’s personal liability, but they can also offer something else – the opportunity to exclude, in its entirety, the duty of good faith between the partners.

The duty of good faith has been a feature of “traditional” partnerships long before the advent of LLP’s. The presence of the duty means that the partners have to make decisions fairly and, to an extent, openly; in many ways it is a safety mechanism that governs precisely what kind of conduct is permissible between partners.

Of course, if you are the kind of business that prefers to make “tough” decisions and believe that when the majority of partners want another partner to “go”, that needs to happen, sooner rather than later, you might view the duty of good faith as something of an inconvenience. In those circumstances troublesome considerations such as ensuring that you arrive at a decision to expel in accordance with a duty of good faith can merely prevent or impede an early departure.

This is a “problem” that can be addressed, to some extent, within an LLP. The starting point is that an LLP is subject to a default regime not dissimilar to “old fashioned” partnerships. This is set out in part 6 of the Limited Liability Partnerships Regulations 2001. However there is little to prevent the members of an LLP from stripping-out the default provisions and replacing them with provisions that are more to their liking. Increasingly that is what is being done.

What is the result? Where the terms of an LLP’s Members’ Agreement have been properly drafted, decisions to expel a member or partner may be passed by the necessary mechanism and the scope for the outgoing partner to protest may well be reduced. That is not to say that there will not still be laws and duties to which the remaining partners may be subject and which may govern what they can or cannot do to their fellows – but excluding the duty of good faith may well be a sign that partners are seeking to loosen the constraints on how they can treat each other.

Solicitors’ practices without internal good faith? In many ways this ought to be shocking. With external investment in law firms now a fact of life and a constantly developing commercial culture, this trend may well be set to continue.

Partnerships, LLPs and Quasi-partnerships: the law

11 August 2021 by ac Leave a Comment

Andrew Cromby

1. The origins of Partnership Law

Partnership law, in its “modern” form, came into existence with the passing of the Partnership Act 1890 (“the Act”). Prior to the Act the law of partnership largely existed as a function of case law and was seen as a tributary to contract law. However, by the time of the Act, it had developed to such an extent that it was felt necessary by Parliament to clarify and codify the position.

The Act is of continuing significance, despite its now historic origins. It remains good law and governs a significant proportion of modern day disputes.

Shortly after the Act, further legislation was passed, the Limited Partnerships Act 1907. Limited Partnerships differ from “ordinary” partnerships because the liability of partners in such entities can, as the title of this Act suggests, be limited in certain circumstances.

However the applicability of the Limited Partnership Act 1907 is restricted – it simply does not relate to the vast majority of disputes that occur – these are typically governed by the Act or, more recently, the Limited Liability Partnerships Act 2000 (“the LLP Act”). Accordingly this article does not consider the 1907 Act in any detail.

The LLP Act, however, is much more relevant to the modern landscape of partnership disputes. It establishes a new “corporate” vehicle for partnerships with limited liability for shareholders or “members” – save in certain circumstances – to which this article refers below.

The consequences where the Act applies to a partnership or where the LLP Act applies to a Limited Liability Partnership can be astonishing and draconian. For this reason it is common for Partners and Members to agree terms that govern their relationship in a Partners’ or Members’ Agreement, respectively, displacing the default provisions under either statutory regime.

It is astonishing, however, how often professional partnerships (including solicitors) fail to adopt any agreement, leaving themselves in the arms of the rules formulated by Parliament – in the case of the Act more than 100 years ago.

Understanding the different regimes for partnerships is essential if you wish to avoid the many pitfalls in this area of law.

2. What is a Partnership?

“Partnership” is defined at section 1(1) of the Act:

“Partnership is the relationship which subsists between persons carrying on a business in common with a view of profit”.

From this it is clear that there are a number of elements which must pertain if a partnership is to come into existence:

there must be a business;
the business must be carried on by two or more persons “in common”;
the persons carrying on the business in common must do so with a view to making a profit.

Most solicitors in private practice find themselves dealing with disputes in relation to professional partnerships or trading partnerships where it is (or appears to be) self evident that a partnership exists, but it is always worthwhile checking to see whether these fundamental elements are in place.

Bear in mind that it is not actually necessary for trading to have commenced – in the case of Khan v Miah [2000] All ER (D) 1647 prospective partners had committed to running a restaurant together and accordingly, having found premises, were getting these ready to open for business. They had also taken preliminary steps to advertise the restaurant’s opening. Relationships between the partners soured before the restaurant’s doors ever opened but, despite this, it was held by the Court that the business was “being carried out” and that the partnership had commenced. Contrast this with the position where parties have merely agreed to enter into partnership at a time in the future, in which case a partnership does not come into existence immediately, in the absence of steps being taken to progress the partnership’s business. If that occurs the prospective date may be brought forward – see Dickinson v Valpy (1829)10 B.&C. 128

It is also worth noting that there must be some evidence that the parties have either expressly or implicitly agreed between themselves some mutuality of rights and obligations – if two parties simply conduct different businesses in “proximity” to each other then it is likely that a partnership has not been created.

3. Partnerships at Will

The starting point is that the Partnership Act 1890 provides a default regime for what is sometimes called a “general” partnership or, more commonly, a “partnership at will” and regulates the relationship of such partnerships with third parties.

This core regime implies terms and duties between partners where they have failed to reach agreement as to any terms themselves. The terms of the Act can be varied by the parties, provided that this is done on a unanimous basis. Section 19 of the Act provides:

“The mutual rights and duties of partners whether ascertained by agreement or defined by this Act may be varied by the consent of all the partners and such consent may be either expressed or inferred from a course of dealing”.

The vast majority of partnerships that a practitioner will come across (particularly professional practices) vary the core position that is set out in the Act by formal written agreement but, even in the absence of a written agreement, it is possible for the parties to vary the terms of the Act by conduct and this is a point worth noting.

4. Unlimited Liability

One of the most striking features of a partnership at will is the fact that this will give rise to unlimited joint personal liability. This arises in the context of various provisions in the Act relating to how partners may be treated by members of the outside world. Some of the key provisions include:

Section 5: Every partner is an agent of the firm and his other partners in relation to the firm’s business. Any act by a partner in relation to normal business of the partnership therefore binds not only him, but also his partners unless, in fact, the partner in question does not have actual authority to act for the firm in the particular matter and the person with whom he is dealing knows that he has no authority or does not believe him to be a partner.

See United Bank of Kuwait v Hamoud & Others [1988] 3ER 418. In this case partners in two separate firms of solicitors were held to be liable on undertakings given on their behalf by a fraudulent solicitor who was, at different stages, a partner in one of the firms and an employee in the other. Whilst a partner in the first firm he gave an undertaking that his firm would provide security for £100,000 in respect of a loan provided to a client of the firm by the United Bank of Kuwait. The solicitor knew that there was no such security in the firm’s possession – he merely wished to “help-out” a client.

The loan was subsequently drawn-down and was not repaid by either the client or the solicitor. The bank called on the firm’s undertaking and made reference to section 5 of the Act. The firm argued that providing fraudulent undertakings could not be regarded as carrying on in the usual way business of the kind carried on by the firm – in their case the business of a law firm. It was argued in this case no legal work was being undertaken for the client – the partner had simply provided the undertaking to the bank for reasons of his own – essentially to please the client.

The Court disagreed and came to the conclusion that a reasonably careful and competent bank would most probably have concluded that there was an underlying transaction of the kind suggested by the undertaking being given and forming part of the solicitor’s business.

Section 7 – partners using credit of the firm for private purposes. Where one partner pledges the credit of the firm for a purpose apparently not connected with the firm’s ordinary course of business the firm is not bound, unless the partner is in fact especially authorised by the other partners – this section does not affect any personal liability incurred by an individual partner.
It is also worth noting that if it’s been agreed between the partners that any restriction has been placed on one of them in relation to their power to bind the firm then no act done in contravention of that agreement is binding on the firm where the relevant third party has notice of that agreement. This is consistent with the position above.

5. Partners – Other points on Liability

Under section 9 of the Act, every partner in the firm is liable jointly with the other partners (and in Scotland severally also) for all debts and obligations of the firm incurred while he is a partner and after his death his estate is also severally liable in the course of the administration for such debts and obligations, so far as they remain unsatisfied, but subject in England and Ireland to the prior payment of his separate debts.

Section 10 of the Act provides that a firm is liable for the wrongful acts and omissions of partners acting in the ordinary course of business or with his other partners’ authority.

Section 11 states that the firm is liable to make good any loss arising out of the misapplication of money/property received by a partner acting within his apparent authority in the course of the firm’s business.

Under section 12 of the Act, every partner has joint and several liability for wrongs under the preceding two sections wherever a liability has arisen for the firm.

This liability arises not only for “true” partners of the firm, but also for employees who are held out to third parties as being partners of the firm. This stems from section 14 (1) of the Act:

“Every one who by words spoken or written or by conduct represents himself, or who knowingly suffers himself to be represented, as a partner in a particular firm, is liable as a partner to anyone who has on the faith of any such representation given credit to the firm, whether the representation has or has not been made or communicated to the person so giving credit by or with the knowledge of the apparent partner making the representation or suffering it to be made”.

This is a major source of concern for salaried partners who are, in many senses, merely employees who have been “badged” as partners, but who nonetheless bear the full brunt of personal joint and several liability. However it is far from uncommon for salaried partners to be given indemnities by the equity partners in this respect, so this position is often addressed.

6. Liabilities of Incoming and Outgoing Partners

When a partner joins a new firm he only becomes responsible for liabilities from the date that he joins. Equally he does not remain liable for any further liabilities that arise in relation to the partnership once he has left – taking into account any period of notice. See section 17 of the Act and Dyke v Brewer (1849) 2 Carr. & Kir 828

7. Partners’ Obligations

What is the core position as regards how profits and losses ought to be shared in a partnership at will? Subject to any agreement to the contrary, the position under section 24 of the Act is as follows:

All the partners are entitled to share equally in the capital and profits of the business and must contribute equally towards the losses, whether of capital or otherwise, sustained by the firm (section 24(1)).
The firm must indemnify every partner in respect of payments made and personal liabilities incurred by him:

(a) in the ordinary and proper conduct of the business of the firm; or

(b) in or about anything necessarily done for the preservation of the business or the property of the firm.

See section 24(2).

A partner is not entitled, before the ascertainment of profits, to interest on the capital subscribed by him (section 24(4)). This position is often modified in written partnership agreements.
• Every partner may take part in the management of the partnership business (section 24(5)).
No person may be introduced as a partner without the consent of all existing partners (section 24(7)).
• Any difference arising out of ordinary matters connected with the partnership business may be decided by the majority of the partners but no change may be made in the nature of the partnership business without the consent of all existing partners (section 24(8)).
Every partner is entitled to have full access to and inspect and copy any of the partnership books of account (section 24(9)).
No majority of the partners can expel any partner unless the power to do so has been conferred by express agreement between the parties (section 25). Expulsion in the absence of an express agreement would be likely to be a grounds for the proposed outgoing partner to seek the dissolution of the partnership.

8. Duty of Good Faith Between Partners

In addition to the specific matters referred to in section 24 of the Act, partners owe each other a duty of good faith in relation to all partnership dealings.

The standard of this duty is extremely high – it is a fiduciary duty and one which goes to the heart of partnership law. Note the statement in Helmore v Smith (1887) 1885 H. 4359:

“If fiduciary relation means anything I cannot conceive a stronger case of fiduciary relation in that which exists between partners. The mutual confidence is the lifeblood of the concern. It is because they trust one another they are partners in the first instance; it is because they continue to trust each other that the business goes on”.

Accordingly a partner is under a duty not to place himself in a position where his interest would conflict with a duty that he owes to his partner therefore a duty not to put himself in a position of conflict and a duty not to make a profit from his position, other than for the benefit of the partnership.

The duty of good faith is one referred to in the Hong Kong case of Kao Lee & Yip (a firm) v Donald Koo Hoi Yan [1995] 1 H.K.L.R 248 (CA, Hong Kong). In that case the defendant did not tell his partners about the existence of a major business opportunity available through one of the firm’s major clients – the Bank of China Group. Instead the partner resigned and established a new practice together with former colleagues who, incidentally, he had solicited. Whilst on notice the defendant took various preparatory steps in relation to the establishment of that business including setting up and registering the partnership vehicle, soliciting clients (including the bank) and arranging new premises. The Court was highly critical of the defendant’s conduct and clarified the following points:

Partners are under a duty to inform their firm of information from or regarding a client which it is in the interests of the firm to know. Unsurprisingly this includes substantial business opportunities of the kind in this case.
It is permissible to take purely preparatory steps to set up a new business and the outgoing partner can canvass new employees but cannot solicit clients and staff of his present partnership, nor can he ask a client for financial assistance or (most importantly) divert a mature or prospective business opportunity which has been developed or negotiated whilst still a partner in the firm.

The defendant was subsequently required to account for a year’s profits generated for his new firm by the bank.

Other duties include:

Partners must render true accounts and full information of all things affecting the partnership to each other (section 28).
Each partner must account to the firm for any benefit derived from him without the consent of the other partners for any transaction concerning the partnership or from any use by him of the partnership property, name or business connection – this applies to transactions undertaken after the partnership has been dissolved or by the death of a partner and before the affairs therein have been completely wound up (section 29).
A partner must not, without the consent of other partners, carry on business of the same nature as and competing with that of the firm, he must account for and pay over to the firm all profits made by him in the event that he does so (Section 30).

9. Dissolution of the Partnership and its Consequences

One of the most alarming features of the Act, in the context of partnership disputes, is the fact that, subject to any agreement between the partners, a partnership at will (again, a partnership for which there is no written agreement) comes to an end at the end of the fixed term (if the partnership is expressed to last for a fixed term) or, if entered into for a single “adventure or undertaking by the termination of that adventure or undertaking” or, if entered into for an undefined time, by any partner giving notice to the other or others of his intention to dissolve the partnership see section 32.

In the last of these eventualities the Act provides:

“… the partnership is dissolved as from the date mentioned in the notice as the date of dissolution, or, if no date is so mentioned, as from the date of the communication of the notice”.

Bear in mind also that a partnership at will can be dissolved by bankruptcy, death or by virtue of the fact that one of the partners “suffers his share of the partnership property to be charged for a personal debt” – section 33.

A partnership can also be dissolved on the basis that an event occurs that makes it unlawful for the business of the firm to be carried on or for the members of the firm to carry it on it partnership – section 34.

Other basis for dissolution by the Court exist under section 35:

(a) where a partner is found to be insane;

(b) when a partner becomes permanently incapable of performing his part of the partnership contract;

(c) when the party, other than the partner suing, has been guilty of such conduct as in the opinion of the Court is calculated to prejudicially affect the carrying on of the business;

(d) when a partner other than the partner suing wilfully or persistently commits a breach of the partnership agreement or otherwise conducts himself in matters relating to the partnership business that it is not reasonably practicable for the other partner or partners to carry on the business in partnership with him;

(e) when the business of the partnership can only be carried on at a loss;

(f) whenever in any case circumstances have arisen which, in the opinion of the Court, render it just and equitable that the partnership be dissolved.

This is an important section of the Act as it includes the “just and equitable” ground for dissolution which is frequently used by parties wishing to seek the dissolution of a partnership. It is capable of having a wide range of factors taken into account. It is sometimes said that reliance on this ground (to be found at section 35(f) of the Act) is a “self fulfilling prophecy” because the greater the scope or vehemence of the dispute between the parties involved in proceedings based on section 35 (f) the more likely it becomes that the Court will find that it is just and equitable that the partnership be dissolved, having regard to the duties of good faith which must otherwise subsist between the partners.

10. Limited Liability Partnerships

The limited liability partnership or LLP is a relatively new entity, although it has now become a familiar part of the landscape, certainly as far as solicitors’ practices are concerned.

Although described as a partnership, an LLP is actually a body corporate with separate legal personality and unlimited capacity. By definition it does not amount to a partnership within the meaning of the Partnership Act 1890.

The members of an LLP act as agents for the LLP but not for each other and are not, generally, liable for the debts and obligations of the LLP unless they voluntarily assume liability on an individual basis.

Members of an LLP may even be employed by the LLP although it appears they will nonetheless be taxed under Schedule D in that scenario.

Most LLPs are governed by a members’ agreement which sets out the rights and obligations of the individual members and which usually mirror the provisions typically found in partnership agreements. There are, however, a few additional “wrinkles” to take into consideration:

• Because LLPs are corporate vehicles they can be wound up on the basis of unfair prejudice to minority shareholders in accordance with section 994 Companies Act 2006 – previously more familiar as an action under section 459 of Companies Act 1985.
• The Limited Liability Partnerships Regulations 2001 sets out, at Part VI, a “default” regime which must be excluded to the extent that the parties do not wish to be bound by its terms: the default provisions include the following:
• All the members of an LLP are entitled to share equally in its capital and profits.
• The LLP must indemnify each member in respect of payments made and personal liabilities incurred by him in the ordinary and proper course of the business of the LLP and in doing anything necessary for the preservation of the business or the property of the LLP.
• Every member has the right to take part in the management of the LLP.
• No person may be introduced as a member or voluntarily assign an interest in an LLP without the consent of all existing members.
• All the differences arising as to ordinary matters conducted by the business of the LLP may be decided by a majority of the members.
• The books and records are to be kept available at the Registered Office and every member has the right when he thinks fit to have access to inspect and copy them.
• No majority of the members can expel any member unless the power to do so has been confirmed by express agreement between the members.

11. Standard Terms in Partnership Agreements

The best way to prevent a partnership dispute arising in the first instance is to have a well drafted partnership deed that sets out properly the rights and obligations of the partners and, in particular, provides for how partners can be admitted and depart from the partnership. The headline points to bear in mind (and which frequently appear in partnership agreements) are as follows:

• That no partner should be entitled to dissolve the partnership otherwise than in accordance with its terms. Excluding the right of outgoing partners to pull the plug can be essential to continuity – especially in larger practices.

• The proportions in which profits and losses are to be shared including provision for:

(a) Lockstep

(b) Annual reviews

• Partners’ contribution to the capital of the firm.
• Whether goodwill is to have a value – which is less frequently seen these days – and if not on what basis should it be valued.
• Confirmation that each partner shall be true and faithful to his partners. Good faith is perhaps the most fundamental obligation which the law imposes on a partner towards his co-partners.
• Whether the partners may engage in other work beyond the activities of the partnership.
• Arrangements for the management of the firm.
• The existence of a mechanism for the admission of new partners, for example by special majority, and a provision that all new partners must sign up to the deed. It has been held that if partners join the firm without signing a deed of admission or at least acknowledging that they are bound by the deed then the partnership agreement ceases to apply and this will give rise to a partnership at will.
• Periods of notice.
• Retirement age (but beware discrimination).
• Expulsion. Common grounds include:

(a) breach of duty, for example competition with the firm;

(b) dishonesty;

• Compulsory retirement.
• Garden leave.
• Payments to be made to an outgoing partner.
• Restrictive covenants (see below).
• Arbitration/mediation provisions. Mediation can be an effective way of resolving partnership disputes, for the reason that the existence of a formal dispute can be so destructive and interfere to such a great extent with the livelihood of the parties involved that often settling the dispute is the only realistic option.

12. Discrimination in Partnership Disputes

Current discrimination applies not only to employees – it also applies to partners and it is unlawful to discriminate, directly or indirectly, against a partner (or member in an LLP) on the basis of their age, disability, religion or belief, sex, pregnancy, marital status, race or sexual orientation. In the case of indirect discrimination (where the application of a provision, criterion or practice by the perpetrator operates to the particular disadvantage of a protected group), the perpetrator will have a defence to a claim of discrimination if he/they are able to show that the application of the provision, criterion or practice can be objectively justified.

Note that the small firm’s exemption from the anti-discrimination legislation no longer applies meaning that all employers have a responsibility to act towards their partners in a non-discriminatory way – there is no saving provision for smaller firm’s, as was once the case.

This is not an article on Employment Law, but in light of the non-existence of a cap on the award of damages that is now available in the Employment Tribunal where there is a finding that a party has been discriminated against (in contrast to unfair dismissal where there is a cap of £66,200 on damages), it is always essential, particularly where you are acting for an outgoing partner that you consider at an early stage whether there is scope for a claim on the basis of discriminatory practices.

Discriminatory practices can occur:

In the process of determining who should be made a partner or member.
In relation to the terms on which a person is offered that position.
In refusing or failing to offer them the position.
In a case where they already hold a position:

a. In the way that they have access to or are refused access to (or where it is omitted to give them access to) benefits.

b. By expelling them or subjecting them to some other detriment.

Consider also whether there may be scope for harassment – equally applicable to partners and members. Some professional partnerships are hotbeds of harassment as the partners and members energetically and enthusiastically violate each others’ and their employees’ dignity and set about creating an environment that is hostile, degrading, humiliating or offensive.

One particularly effective tool in the partnership litigator’s arsenal is the discrimination questionnaire. This is designed to assist a partner who considers that they may have been unlawfully discriminated against or subjected to harassment to decide whether to institute proceedings. The questionnaire is in prescribed form and enables the complainant to gather information about their complaint. There are specified time limits within which a questionnaire must be served on the partnership. Whilst the partnership is not under a legal obligation to respond to the questions, if it fails to respond to the questions within a period of 8 weeks of the questionnaire being served or if it provides evasive answers to the questions, a court or tribunal will be entitled to draw adverse inferences against the partnership on account of its failure to reply or its failure to provide adequate responses to the questions.

The threat of an uncapped award of damages to an outgoing partner – incidentally giving them the means to fund further Court action – is one that can be most unpleasant to continuing partners – particularly where there are no adverse costs consequences for the claimant, unless they have, in the opinion of the tribunal, acted vexatiously, abusively, disruptively, or otherwise unreasonably in bringing or conducting proceedings or the bringing or conducting of the proceedings has, in the tribunal’s opinion, been misconceived i.e. having no reasonable prospects of success.

You should also be aware that discrimination claims can be pursued whilst a partner is still “in situ”, which has the potential to make partnership meetings very uncomfortable affairs!

Also remember that the adverse publicity which a discrimination complaint can bring upon a partnership would certainly be damaging to its standing in the market, particularly if such complaint is upheld.

13. Quasi partnership

It is also worth mentioning the concept of “quasi partnership”, which is also a fertile source of disputes. In fact such disputes are more properly considered to be “shareholders disputes” by virtue of the fact they arise where two or more individuals set up business together, using a company to run their business – but to all intents and purposes act as though they were in partnership together.

The leading case in this area is O’Neill v Phillips 1999 BCC 600HL. It may be the case that the shares in that vehicle are owned equally by the parties or alternatively, as was the case in O’Neill v Phillips, the shareholdings may be split so as to reflect different levels of capital investment, effort put into the business, etc.

However, provided the parties have acted at all times as though they are in partnership together then they can be said to owe each other a duty of good faith with some similarity to that enjoyed in a “classic” partnership.

Partnership law, as such, does not apply in those circumstances. The specific consequence of O’Neill v Phillips is that, in the event that one of the partners acts in a way so as to prejudice the interests of his fellow shareholder (frequently a minority shareholder) then it may be possible to apply to the court either for an order to wind up the company or, more commonly, for an order that the minority shareholder has his shares purchased by the majority shareholder.

The basis of the purchase in such cases is that a minority shareholder has his shares valued on a pro rata basis without any discount being given to reflect what would normally be the lower commercial value of minority shareholding. Actions can be brought under section 994 of the Companies Act 2006 – more familiar to some as the section 459 action under the old Companies Act 1985.

The section provides:

“994 Petition by company member

(1) A member of a company may apply to the court by petition for an order under this Part on the ground—

(a) that the company’s affairs are being or have been conducted in a manner that is unfairly prejudicial to the interests of members generally or of some part of its members (including at least himself), or

(b) that an actual or proposed act or omission of the company (including an act or omission on its behalf) is or would be so prejudicial…”

A word of warning: partnership disputes are considered to be some of the most expensive and time consuming disputes that arise. Shareholder litigation under section 994 of the Companies Act 2006 is equally, if not more, expensive and protracted.

14. Typical Partnership Disputes

So, having set out the basic legal framework within which disputes arise, what are the most common disputes? These include allegations and claims concerning:

Partners not pulling their weight.
Loss of major client or type of work.
Fraud.
Profit shares.
Personalities.

It is equally important that any agreement between parties, whether enshrined in an LLP members’ agreement or a standard partnership deed should provide for possible consensual resolution of disputes by negotiation, mediation or, ultimately, whether any dispute should take place by way of arbitration or litigation.

Is a Partnership truly over, when all is done but not said?

7 February 2020 by admin Leave a Comment

When the time comes to wind your partnership down make sure that you take the necessary steps to conclude matters formally. Equally, if the nature of your business has changed, but you intend to keep your partnership in existence, make that clear in order to avoid unwanted disputes…

At the end of the life of a partnership, it needs to be wound up. Failing to do so leaves the partners (and if they are in a Limited Liability Partnership, the LLP itself) at continuing risk of liabilities being incurred in their name. Often partnerships have documented procedures for winding up their affairs – typically enshrined in the partnership or LLP agreement. If so, those procedures need to be followed. In any case, absolute clarity is needed regarding the fact that the partnership and its business has been concluded.

The 2019 case of Boyle v Burke & Anor [2019] EWHC 3364 (Ch) (10 December 2019) demonstrates that it is not a safe course simply to assume, from the conduct of some or all of the partners, that a partnership is at an end…

The facts

In this case the Claimant believed that the sale of the partnership brought about the partnership’s dissolution.

The terms of the partnership were set out in a partnership deed dated 27 January 1987. Clause 2.43 provided for the consequences of a dissolution of the partnership – including the entitlement of partners to a lump sum in respect of pension benefits on dissolution.

On 1 October 2012, the Defendants transferred the whole of their legal practice and other businesses to a company which they had set up to operate as an estate-agency and financial-planning business. The Claimant had retired in 1998 and had been in receipt of annual pension payments. He believed that he was now entitled to the lump sum payment as he had not been a part of discussions or the decision making process in the reallocation of business and assets. He claimed that the lump sum was due on 1 October 2012, upon the transfer of the partnership of the business to the company set up by the Defendants. He claimed that this was effectively a dissolution of the partnership.

Conversely, the Defendants argued that no dissolution had taken place pursuant to Clause 2.43, upon the transfer of the business to the company, because they did not intend or agree to any such dissolution and no such agreement could be inferred. It was also pointed out that the partnership retained the lease of the business premises, which it sublet to the Defendants’ company for a small profit.

The decision

The Court held that Clause 2.43 was predicated on there being a ‘final dissolution of the partnership’. The Claimant had to show that the partnership had been dissolved in law as of 1 October 2012. For that to have been the case, there must have been an agreement by the Defendants to dissolve the partnership. Such an agreement could be inferred as a matter of fact but not as a matter of law, following the case of Chahal v Mahal [2005] EWCA Civ 898. In Chahal, it was held that it would be very difficult to establish that an agreement to dissolve the partnership had occurred where one of the parties was not involved, or involved very little, in the decisions to transfer the business and its assets. In addition, delegated authority to continue business on behalf of the partnership, even as far as acquiring new assets, did not automatically equal a right to dissolve the partnership without an agreement between the partners.

This applied directly to Boyle v Burke as the Defendants were able to show that there was no agreement to dissolve, because they intended the partnership to continue – in fact, they most likely wished the partnership to continue to stop Clause 2.43 from coming into effect. The Claimant could not prove that the partnership was dissolved on the transfer of its business to the company.

The Court also made reference to National Westminster Bank Plc v Jones [2001] 1 B.C.L.C. 98. In that case the mere cessation of the partnership’s business was insufficient to establish that there had been a dissolution of the partnership. There can be many instances whereby a partnership ceases to have any business or assets, and yet the partners intend the partnership to continue e.g. starting a new venture or improving their positions with regard to tax liability. In Boyle v Burke, the dissolution could only have been effected with the agreement of the Defendants, and that was not present.

In the judgement handed down by Mr Michael Green QC, attention was drawn to Clause 2.43 and references made in the partnership deed to the partnership being dissolved. It was found that because the purpose of Clause 2.43 was “…to deal with the consequences of the partnership being dissolved the partnership must have been dissolved as a matter of law for those consequences to take effect.” The partnership’s business was not a defined term in the partnership deed and that meant that determining whether all of its activities had ceased or were intended to cease was not readily done.

Conclusion

If it’s your intention to wind up a partnership make sure that you do so properly, in accordance with any partnership agreement and, generally, with the consent of all the partners. Laying the ghost to rest is an essential part of any partnership’s natural cycle. But if you intend to change the nature or structure of the business of the partnership, but for the partnership to continue, make that clear too!

Andrew Cromby and Benjamin Turner

The Role of the “Honest Broker” in Partnership Disputes

31 December 2019 by admin Leave a Comment

Bitter arguments and disagreement are features of many long term relationships. Familiarity breeds contempt and all too often in partnership disputes the relations between parties have disintegrated to the point that direct communication is all but impossible. That is often what sends the parties reaching for their solicitors.

The problem is that, whilst there are times when the involvement of solicitors is needed, they can cause as many problems as they hope to solve. When added to an already potent cocktail of financial difficulty and personal dislike, the involvement of solicitors, with their point-scoring and competitive ways, can become the death of all reason.

Is there another way? Well, one option which is worth exploring is whether there is any third party who may be able to act as honest broker between the opposing sides. He or she must be respected by both sides, bear neither any animosity and, ideally, have an interest in seeing an outcome that is in everyone’s best interests. Such people are found in partnerships more often than might be thought. Former managing partners, now retired and of a different generation (sometimes a paternal or maternal figure) can be just the ticket and be genuinely motivated to try to sort matters out.

Effectively such individuals act as mediators and can do so over an extended period. This brings the advantages of mediation – and without time pressure dictating that everything should be sorted out in, say, just a day or two. The honest broker can receive and deliver information and proposals detached from personal enmity and, where they are intimately acquainted with the working of the partnership, may be able to make suggestions of their own that could facilitate a solution. They may also have sufficient standing or stature to knock heads together. Better still, such individuals frequently agree to participate in negotiations without charge. Even where the parties to a partnership dispute retain solicitors, the cushioning effect of an honest broker is usually clear and benefits all involved.

So, all in all an option worth considering, where a suitable individual can be identified.

When Can a Partner Forfeit His Partnership Share?

23 December 2019 by ac Leave a Comment

What remedies might a partnership seek against one or a number of its partners, where they have acted in breach of partnership duties in contemplation of leaving to join another business?

Limited Liability Partnerships (“LLPs”) are currently a popular, if not the most popular, vehicle for professional businesses in the English legal system. If any one thing can be said to underpin the relationship between partners, it is trust. The classic expression of that concept appears in Helmore v Smith (1) (1886) 35 Ch D 436, where Bacon V-C declared:

“…I cannot conceive a stronger case of fiduciary relation than that which exists between partners. Their mutual confidence is the life blood of the concern. It is because they trust one another that they are partners in the first instance; it is because they continue to trust one another that the business goes on.”

This principle was revisited by Mr Justice Newey in the more recent case of Jeremy Hosking v Marathon Asset Management LLP [2016] EWHC 2418 (Ch) – a case relating to the forfeiture of profit share by a partner (member) in an LLP, in the circumstances of a team move.

The Facts

Marathon Asset Management LLP carried on an investment management business. One of its founding members (Jeremy Hosking) gave notice of his intention to retire – in the process becoming a “Non-Executive Member” of Marathon, in accordance with the LLP agreement. As such he was entitled to receive only half as much profit share as an Executive Member.

After the notice had been given the LLP initiated arbitration proceedings against Mr Hosking, alleging breach of contractual and fiduciary duties owed to the LLP. The accusation was that he had discussed the possibility of starting a new business with four of its employees including the production of a business plan “outlining his thoughts”. The breaches were proven to the satisfaction of the tribunal which determined that the LLP had lost the chance of retaining three individuals (which it assessed at 5%), known as the “Global Three”. The arbitrator went on to determine that compensation of £1.36 million was payable, as a consequence.

The tribunal also came to the conclusion that the LLP was entitled to equitable compensation and that Mr Hosking should forfeit 50% of the profit share that he had received in respect of the period during which he had breached his contractual and fiduciary duties. Eventually he had to repay some £10.3 million. The award was appealed to the High Court on a point of law; whether the share of profits of a partner (whether in a partnership or as a member in an LLP) can be subject to the principle of forfeiture on the basis of a breach of fiduciary duties.

The Court’s Decision

By drawing on and comparing agency law with partnership law the Court found that part of Mr Hosking’s profit could indeed be forfeited and that it was “proportionate and equitable” that this should occur in circumstances where the arbitrator had found that he was “dealing with a series of serious breaches of fiduciary duty” and “that forfeiture of a 50% share of Income Profits, distinct from the 50% share received by way of `half rations’, [was] not inconsistent with, or excluded by, the terms and structure of the LLP Deed”.

The court noted that there is an important conceptual distinction between profit share and remuneration in partnerships and limited liability partnerships. Although the distinction between the two may not always be clear, it is probably sufficient to be aware the possibility of forfeiture can arise, where there are serious breaches of partnership duty.

Interestingly, although the court was dealing with matters arising in the context of an LLP, it seems clear that the judgment is equally applicable to traditional partnerships.

Conclusion

Departing partners need to recognise that serious financial consequences can flow from their failure to have regard to their partnership duties.

This article was written by Andrew Cromby, a Partnership Specialist at Weightmans LLP and Alice Galler.

andrew.cromby@weightmans.com

www.weightmans.com

Tel: 0345 073 9900

Partnership Law and Team Moves – Mind Your Obligations or Pay the Price?

23 December 2019 by ac Leave a Comment

Recent developments in partnership law may have given those contemplating a team move pause for thought. Andrew Cromby and Alice Galler consider the impact of the decision in Jeremy Hosking v Marathon Asset Management LLP [2016] EWHC 2418 (Ch).

If any one thing can be said to underpin the relationship between partners, it is trust. The classic expression of that concept appears in Helmore v Smith (1) (1886) 35 Ch D 436, where Bacon V-C declared:

“…I cannot conceive a stronger case of fiduciary relation than that which exists between partners. Their mutual confidence is the life blood of the concern. It is because they trust one another that they are partners in the first instance; it is because they continue to trust one another that the business goes on.”

This was quoted, once again, by Mr Justice Newey in the more recent case of Jeremy Hosking v Marathon Asset Management LLP– a case relating to the forfeiture of profit share by a partner (member) in an LLP, in the circumstances of a team move.

The facts

The Court’s decision

Interestingly, although the court was dealing with matters arising in the context of an LLP, it seems clear that the judgment is equally applicable to traditional partnerships.

Conclusion

Departing partners need to recognise that serious financial consequences can flow from their failure to have regard to their partnership duties. Those contemplating team moves, in particular, should think carefully before they invite or encourage others to join them at a new firm – or they may have to pay the consequences.

No Let Out for Downtrodden Partners

27 November 2019 by ac Leave a Comment

They say that familiarity breeds contempt and working with the same partners, year after year, in what is all too often a commercially pressured environment, can (and does) result in personal and professional relationships breaking down. Partnership breakdowns are often likened to bad divorces – and for good reason. Those involved have spent many years getting to know (and sometimes dislike) each other, before they reach the point of no return and simply cannot bear to continue in business together. Often the situation is made more complex by groups of partners ganging up on an individual and treating him badly.

This gives rise to an interesting question – can a partner ever be treated so badly that he or she is entitled simply to walk away from their partners, taking the view that their relationship is at an end as a consequence of the poor treatment that they have experienced?

For many years there was considerable debate on this point. It is well established under English contract law that it is possible for the terms of a contract to be breached so fundamentally that the party offended against is entitled to treat his own continuing obligations under the contract as being at an end – if that “repudiatory” breach is accepted very promptly. But in relation to partnerships, the position is different. That’s because the relationship between partners is considered to go beyond being just a contract; it’s underpinned by trust and the partners owe each other strong fiduciary duties.

In the case of Hurst v Bryk and Others [2000] All ER (D) 432 the court held that partners are not entitled simply to walk away from the obligations and duties that they owe each other – even where they are treated in a way which is inconsistent with the terms agreed within their partnership. Treat a partner badly? That doesn’t mean that he’s entitled to consider himself released from his obligations under the partnership agreement.

What then of the position within Limited Liability Partnerships (LLPs), which are, perhaps curiously, corporate entities? LLPs look and feel like partnerships but have separate legal personality from that of their members – “old fashioned” partnership law simply does not apply to them. Does the doctrine of “repudiatory breach” apply to LLP agreements or would they too survive serious, fundamental, breaches? In the blink of an eye (about 15 years) the court answered that question too – “no”. In line with traditional partnerships, LLP agreements survive breaches by the members. One member, treated inconsistently with the terms of an LLP agreement, cannot claim that the governing constitution of the LLP is destroyed. Of course, the case was decided on its own facts, but that seems to be the accepted interpretation of the court’s judgment in Flanagan v Lionsgate and Others [2015] EWHC 2171 (Ch).

For disgruntled partners the threat of being able to “do away” with the LLP Agreement was potentially a powerful one. Now it seems more likely that a badly treated member of an LLP will need to seek other remedies – damages or possibly even attempting to wind up the LLP on just and equitable grounds, where that is possible.

For new partners and members the point to bear in mind is that partnerships and LLPs are strong entities – in many ways greater than the individuals which comprise them. It is essential to know who you are getting into business with and to keep in sight your exit route, in the event that things go wrong. Otherwise you can find yourself put upon with no immediate escape.

This article was first published by AON as an insight piece on their website – see here.

How Bulletproof Is Your Business?

20 November 2019 by ac Leave a Comment

How Bulletproof Is Your Business?

Once upon a time the most popular business vehicle for accountants was a partnership. Steeped in tradition (the governing legislation for most partnerships was entered onto the statute books in 1890), it is only relatively recently that accountants, together with other professionals, have embraced alternative business vehicles including companies and limited liability partnerships (LLPs).

Companies and LLPs have a number of advantages for those running a business. They have separate legal personality; this means that they are distinct and separate entities from their owners, employees, directors or members. Consequently their existence creates a “firewall”, blocking most (but significantly, not all) personal liability for the owners/operators of the business.

For instance, it is entirely possible to limit the personal liability of the owners/operators of a company or LLP in respect of their negligently given advice – provided that the businesses ensures that its terms of business are properly in place and these provide that clients agree only to bring such claims against the business and not against the individual adviser who may have been responsible for the bad advice. Indeed, this has been the motivation behind many professional practices converting to LLPs and companies from “old fashioned” (unlimited liability) partnerships.

However, that does not mean that LLPs or companies provide an entirely risk-free environment for business owners. Running your business through an incorporated entity is a good place to start if you want to protect your personal position – but there are ways in which the protection afforded by such entities can be pierced.

The main risk to professional business owners comes from the consequences of running their business badly. The risk is that:

A previously successful business starts to falter.
The finances of the business take a turn for the worse and the business slides towards insolvency.
The owners of the business do not recognise or effectively deal with the situation until too late in the day. The business slides into insolvency.

The consequence of this is that the owners and operators of the business can find themselves, after an insolvency event, with potentially crippling personal liability. This might arise under s214A of the Insolvency Act 1986, for instance. This gives rise to the possibility that members of an LLP which has become insolvent will have money reclaimed from them (personally) for failing to recognise, when they should, that they continued wrongfully to trade the insolvent business. Virtually identical provisions exist in relation to company directors.

There is another risk – particularly in relation to LLPs. LLPs are tax transparent. Individual members remain personally liable for their tax. However many firms operate joint tax reserves, held against the individual members’ liability for tax. If a firm becomes insolvent, those tax reserves may be dissipated by the LLP – leaving the individual out of pocket for substantial tax.

On top of those difficulties sits another element which can pressurise the finances of LLP owners – personal guarantees given by members in respect of borrowing and rent. If an LLP becomes destabilised all of these potential liabilities can descend at once, rendering members of an LLP (and directors of companies in similar positions) staring into a financial abyss. t

So, running a business through an LLP or company is a good first step to protecting your position – but no owner/operator of a business should proceed on the basis that they are completely fireproof. It is always worth looking at the circumstances of your business commercially, as well as legally, in case the corporate protection that you thought was in place is swept aside.

Always a cobbler worst shod – how well organised is your firm?

28 April 2017 by ac Leave a Comment

All too often professional advisers lavish care and attention on their clients, helping them to achieve their commercial objectives, but neglecting to ensure that their own affairs are properly in order. The consequence? When accountants fall out with each other shortcomings in the internal governance of their business are exposed and problems multiply. However, many of those can be avoided with just a little prior planning.

Many professional business owners simply do not appreciate that, in the absence of a clear (preferably written) agreement regulating their relationship with each other, they are likely to be subject to a default regime. Rules and obligations are often imposed on them as a matter of law, depending on the kind of vehicle they use to run their business. For accountants, popular business vehicles include partnerships, Limited Liability Partnerships (LLPs) and limited companies.

Partnerships

Whenever two or more individuals go into business together, other than through some kind of corporate entity, there is a strong likelihood that they will be deemed to have formed a partnership; no paperwork is required. That means that their relationship is subject to the provisions of the Partnership Act 1890, although the operation of that Act can be excluded by agreement. Absent such agreement the consequences can be unforeseen and unwanted and can include:

Each partner having unlimited liability for the acts of the others.
A lack of clarity regarding ownership of the assets of the partnership – and a presumption that they should be shared equally if the partnership comes to an end, however they were contributed.
No satisfactory means of breaking a deadlock.
An automatic right for any partners to dissolve the partnership without notice.

LLPs

Although called “partnerships”, LLPs are actually corporate entities with a separate legal identity – like companies. LLPs have “members” rather than “partners”, although the terms are often used interchangeably.In the absence of agreement to the contrary, the relationship between the members is governed by the default provisions set out in the Limited Liability Partnerships Regulations 2001. These include:

All members having an entitlement to share equally in the capital and profits of the LLP.
Every member having the right to take part in the management of the LLP.
Decisions in relation to “everyday” matters being decided by majority.
No right to expel a member.

Limited companies

The rules governing the running of limited companies can largely be found in the Companies Acts. Suffice to say that the default provisions for corporate governance are very unlikely to represent a satisfactory landscape for those in business and it is always prudent to enter into additional documentation to regulate the relationship between shareholders.

What can be done?

Despite the chaos that can result, a surprising number of businesses have an out of date partnership or shareholders’ agreement, or none at all. Sometimes the reason for this is simply that no one thought that one was necessary. This is to be avoided:

Don’t rely on default provisions to determine how your firm is run.
If you are starting out with a new business decide, at the outset, how you want the business to work. Is one partner contributing more capital? Will another be more proactive in getting work through the door?
Put a partnership/shareholder agreement in place before you start the new business – certainly before you think that you need it. Get professional assistance with this; it will be worth it in the long run.
Review your agreement every few years to make sure that it meets the continuing needs of your business.
Consider whether you want your agreement to provide for alternatives to court action – perhaps some form of conciliation procedure or to provide for arbitration in private rather than a hearing in public.

This article was first published in the ICAEW’s “Practicewire News” on 28 April 2017.

Quasi-partnerships: when shareholders become partners

16 March 2017 by ac Leave a Comment

Companies and partnerships are two very different animals, but there are circumstances when the shareholders in a company are considered to be “quasi-partners”. Alice Galler and Andrew Cromby of Bracher Rawlins explain what quasi-partnerships are, how they can come into existence and the consequences, when they do…

What is a quasi-partnership?

A “quasi-partnership” can arise when two or more individuals decide to establish or develop a business together, using a corporate vehicle – typically a limited company. This doesn’t happen in every case, but it can happen when the individuals developing the business share risk and reward, jointly manage their business and act in a way which is consistent with them owing each other a duty of trust.

This happens more often than might be expected. Small family businesses, friends founding a commercial dynasty together and long term business associates operating though corporate vehicles are all capable of being deemed to be quasi-partnerships.

If the arrangement is such that it amounts to a quasi-partnership, what are the consequences?

One of the main consequences is that the court will grant to a minority shareholder in a quasi-partnership additional protection from being unfairly prejudiced by the majority shareholder/s. In particular, if a minority shareholder is ousted from the business (or, equally, removed from control) it may be possible for him to bring a claim in accordance with section 994 of the Companies Act 2006.

If successful such a claim results in the shares of the minority shareholder being purchased by the majority – but without any discount being given in relation to the price of the shares, to reflect the fact that they represent a minority (non-controlling) shareholding. Instead they are valued pro rata to the total value of the company’s shares.

Quasi-partnerships are nothing new. The concept was first developed in the case of Ebrahimi v Westbourne Galleries 1973 AC 360, a decision of the House of Lords, which has now been replaced by the Supreme Court as the highest domestic English court.

The leading case in this area is currently O`Neill v Phillips 1999 BCC 600HL, which concerns an employee being given shares in a business by the owner and the battles that ensued to control the division of profits and the running of the business. It’s a lesson in what can go wrong when business partners don’t have a proper agreement in place regarding the ownership and running of a business.

Beware litigation…

Disputes in relation to quasi-partnerships are notoriously expensive and (even for litigation!) acrimonious. When it comes to litigation, prevention is always better than cure. A well-drafted shareholders’ agreement will significantly reduce (or even extinguish) the possibility of a quasi-partnership claim. The best time to put such an agreement in place is before your business starts to take off. If litigation can’t be avoided, it is important to act quickly and not to delay bringing a claim, failing which a party’s position can be damaged.