What is a business partnership?

Summary

A partnership is a relatively simple way for two or more people to own and run a business together. However partners do not enjoy any protection if the business fails and you should definitely get a written Partnership Agreement drafted.

How to make a business partnership legal

This is a question we’re often asked to consider – but normally only when things have gone wrong in a business relationship. It comes up when business partners or directors want to go their separate ways, whether amicably or otherwise, and sometimes occurs when one partner feels the other isn’t pulling their weight and wants to make changes and isn’t sure whether they need their partner’s approval.

So, what is a business partnership and what makes it legally binding?

A partnership automatically comes into effect when two or more people carry on business together with a view to make a profit. The partners share the risks, costs, and responsibilities of being in business. Each partner is self-employed and, usually, shares in the decision-making. However, they are also personally responsible for any losses or debts that the business runs up, or any damages claims made against the partnership, unlike in a limited company.

A partnership doesn’t need to be in writing but, if it is not, then it is governed by the Partnership Act 1890 which sets out the default rules governing the partnership. In practice, the default rules are inappropriate for virtually all partnerships.

For example, under the default rules, a partner cannot be dismissed from the partnership, even for misconduct. Instead, the partnership as a whole will need to be dissolved (i.e. brought to an end). Similarly, a partner cannot leave the partnership for any reason without it being dissolved, and this is the case even if they died or became bankrupt.

When a partnership is dissolved, then the partners are entitled to their share. Unless they can all come to an agreement, the partnership’s debts and liabilities must be paid off and then any surplus is paid to the partners. If there is a shortfall, then the partners must pay this into the partnership funds. This can often mean a partner putting their house at risk.

For any partnership that is likely to last for more than a brief period, it is likely that over time partners will want to leave and others want to join. There may be a need to change what each partner takes out of the business as the business develops or where partners have other interests too.

For these and other reasons, it is dangerous to enter into a partnership without a written partnership agreement. In a partnership agreement, you can agree your own rules rather than rely on the default rules in the Partnership Act. However, it’s not a good idea to draft this yourself. Even with a written agreement, the default rules will come into play to cover any area that you left out. It is important therefore to get this drafted by a solicitor to avoid this and make sure everything is covered and does covers what you want it to.

Often business owners will talk about a partnership when what they really mean is something different from a legal perspective. If a limited company is formed then, although the directors may choose to describe themselves as being ‘partners’, they are in fact co-directors with all the rights and responsibilities that this entails. There are certain advantages of forming a limited company, including the limitation of liability and usually some tax advantages. But it’s important to realise that directors also take on formal legal responsibilities too (see Understanding your duties and responsibilities as a Director).

So, if you are in partnership, or are thinking about going into partnership with someone else think carefully about how you want to operate and what protections you might need in place.

Gary Cousins
Business Solicitor

For free advice on this topic please call us on 0845 003 5639.