Partnership Deed – Do I need one?

Oh yes you do!  More importantly, it needs to be professionally drafted by those who are familiar with the pitfalls.

Without a formal Partnership Deed, the relationship will be governed by the Partnership Act 1890 and, for example, means that any partner can serve notice at any time to terminate a partnership with immediate effect.  How frightening is that?

Last week, the Court of Appeal handed down a judgment in a farming partnership dispute between parents and son.  Typical of farming families, the son worked in the business for many years for little salary in the expectation that he would ultimately inherit the farm business.  In this case, there came a point where the son and the parents could not agree on important decisions relating to the future of the business and the son decided that he had to leave and make his own way.  The Partnership Deed which had been prepared by family solicitors provided that the remaining partners could elect either to wind up the business or to continue the business and buy out the outgoing partner’s share.  The dispute was whether the son’s share should be based on the book value of the assets as shown in the accounts or at market value, which typically would be significantly higher.  The Court of Appeal decided unanimously that, on the proper construction of the Partnership Deed, the answer is that the son’s share should be valued at market value.  To decide otherwise would mean that a continuing partner could elect to buy the outgoing partner’s share at book value, only to then re-sell at market value and reap a windfall.  Although in this particular case, it was the son who had resigned, the Court pointed out that the situation could have been the other way around, with the parents wishing to retire and serving a notice on the son, who could then elect to buy the parents’ share at book value, only to then wind up the business and sell the assets at full market value.  Clearly, an unfair outcome.

The Court had to determine the point in this case because the Partnership Deed did not clarify how an outgoing partner’s share should be valued, but referred to “net” value and consequently the lawyers had to argue about what this meant.  An expensive litigation which could have been avoided had the Partnership Deed been drafted correctly at the outset.

Brendan Pang and Helen Williams at Stokes Partners LLP successfully acted for the son in this case.

When individuals get together to run a business, they are all “friends” and do not wish to think about a Partnership Deed which is regarded as an unnecessary expense.    This is true but for the fact that the document is usually needed precisely when there is a dispute and the partners are no longer “friends”.

Frequently, a lawyer or accountant is asked to provide a “simple document”.  This is possible if it is a simple partnership with equal shareholding, contribution of capital and profit share.  Where the parties are to all intents and purposes equal, a simple  Partnership Deed would be possible as the terms would be mutual and apply equally to all the parties.

Where the business is more complicated or the ownership and management structure is unequal, a Partnership Deed becomes even more important and invariably will be bespoke to the requirements of the parties.

Farming partnerships are treated by the law as no different to any other business partnership.  There are no special presumptions or rules of interpretation.  However, family farming businesses invariably tend to be more complicated, with family history and aspirations for future generations.  As such, there is rarely a “simple document” for a farming partnership.

Very often, the farmer has not even addressed his mind to issues about succession.  Some do not wish to do so, in the same way they do not wish to make a Will until they are literally on their death bed, or when their accountant says it will cost them a fortune with the taxman!

The solicitor drafting the Partnership Deed must consult with the accountant to ensure that the agreement is consistent with the way the accounts are prepared.  Most accountants will prepare accounts on the basis of tax efficiency, but the details are not necessarily understood by the farmer, who may have his own ideas about who owns what, and what happens to the assets when he dies.  The farmer may even instruct his lawyer to draw a Will on incorrect assumptions about the ownership of the assets, with the consequence of a dispute arising after death.

The key issues in most agreements are usually about how capital will be contributed and profits shared.  But no one can predict what the future holds and the agreement should therefore address what is to happen when someone joins or leaves the partnership.  How would the capital be repaid, to ensure that the on-going business is not crippled by debt?  How is that outgoing partner’s share to be valued?  What would happen in the event of death, illness or insolvency and which assets belong to the partnership and which do not?  These are just examples of some of the important issues that one has to consider, in order to avoid unwanted expensive disputes.

Written by Brendan Pang, Partner at Stokes Partners LLP