Partnerships, LLPs and Quasi-partnerships: the law

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

(c) Appeal mechanism

• • 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;

(c) insolvency.

• • 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.