Partnership disputes: rights and obligations in unincorporated partnerships

12 September 2022

What is a business partnership?

According to Section 1 of the Partnership Act (PA) of 1890, a partnership is a relationship that exists between individuals who carry on a business in common with the intention of making a profit.

The partners cannot decide for whether a partnership exists or not (though many partnerships will be formed intentionally). The nature of the parties’ agreements, not the parties' claimed intentions, is what the courts look at when determining whether a partnership exists.

Although the partnership must be operated "with a view to profit," real profit is not required. Therefore, in this scenario, intention is what counts. Sharing in the business’ net earnings is conclusive proof of a partnership.

The precise date of start of an unincorporated partnership can be challenging to pinpoint, but it may be crucial when evaluating the tax implications or the ability of partners to bind one another.

What are the responsibilities of a partner in a partnership?

Certain provisions set out in the PA 1890 are inferred into the partnership relationship, but they can be overridden by a contrary agreement between the partners and are typically replaced by a well-written partnership agreement. These, for instance, comprise:

  • A right to an equal division of capital and profits (section 24(1) of the PA 1890).
  • A requirement that the firm reimburse each partner for any payments paid or liabilities assumed by them in the course of the firm's activity or "necessarily done" in order to protect the firm's assets (sections 24(2)(a) and (b) of the PA 1890).
  • A right to interest on contributions made to the partnership (section 24(3) of the PA 1890).
  • A requirement that each partner participate in the partnership's management (section 24(5) of the PA 1890).

A majority of the partners must agree to resolve any disagreements on routine business affairs under section 24(8) of the PA 1890, with the exception that the nature of the partnership business cannot be changed without the support of all of the current partners.

Partners owe each other fiduciary duties which means they must act honestly toward the other partners, act for the benefit of the partners as a whole, avoid placing themselves in a position where their duty to the firm and their own interests conflict, disclose all information that is pertinent to the partners and refrain from making an unauthorised personal profit. The obligation extends to the discussions that led to the partnership's formation and is still due to the partnership by a departing partner after a dissolution until the business is wound up.

The obligation also includes the need to report any benefit received as a result of a partnership-related transaction carried out without the approval of the other partners or as a result of a partner's personal use of partnership assets, goodwill, or business connections.

Section 30 of the PA 1890, which requires partners to account for all profits gained from operating businesses that are similar to and compete with those of the firm without the approval of other partners, reflects another facet of the greatest good faith principle.

A strange exemption to the rule allows a partner to purchase the stock of another partner in the firm without first informing the other partners.

Partnership agreement

If a well-written partnership agreement is in place, it will specify the circumstances that would constitute grounds for dissolving the partnership and the procedure to be used in the event of a dispute. It will specify how the division of assets and liabilities is to be made.

It will outline how to convene meetings, how to eject a partner, and what voting rights each partner has. What happens in the event that a partner dies and how a partner can retire.

What happens if business partners fall out?

The parties should review any partnership agreements that may exist. What a partner can and cannot do is outlined in the Partnership Act if there is no partnership agreement.

At a partner's request, a court may dissolve a partnership for the following reasons:

  • A partner's permanent infirmity.
  • Partner behaviour intended to hinder the operation of the business.
  • A partner's willful or continuous violation of the partnership agreement or behaviour that makes it impossible to continue doing business with him as a partner.
  • The dissolution of the partnership is just and equitable.
  • The partnership business can only be operated at a loss.

(PA 1890, Section 35)

One or more partners may submit an application for an order of dissolution under Section 35, but they may do so in either the County Court or the High Court's Chancery division. The County Court will only hear cases when one of the following applies:

  • The value of the partnership assets does not exceed £350,000;
  • All of the partners have approved the dissolution action.

Finalisation of the partnership business

The partnership business and assets must be wound up after the firm has been dissolved. When a partnership is wound up, all of its assets must first be valued before any debts are settled and any remaining funds are distributed to the ex-partners. During this step, the partners will create the dissolution accounts.

Running the dissolved company while it is being wound up

The right of each partner to bind the business, as well as the other rights and obligations of the partners, survive the dissolution of a partnership insofar as may be necessary to wind up the affairs of the partnership and to complete transactions started but unfinished at the time of the dissolution but not otherwise.

Any restrictions on the partners' authority outlined in the partnership agreement shall remain in effect. For instance, during the winding-up phase, a restriction under the partnership agreement requiring the partners' unanimous consent for the purchase or sale of real estate would still be in effect.

Bankrupt partners are not covered by Section 38; regardless of whether their bankruptcy caused the firm's dissolution or otherwise, they are not permitted to bind the business after the dissolution.

In the event of a dissolution, creditors of the partnership enterprise are not adversely affected and may continue to pursue claims against either partner (section 17, PA 1890).

Outgoing partners' entitlement to a portion of profits made after his death or departure

If a partner has passed away or otherwise ceased to be a partner and the remaining partners continue the partnership business without settling accounts between the company and the departing partner or his estate (i.e., the business is conducted other than to purely wind-up affairs), the departing partner or his estate is entitled, at his discretion, absent any other agreement, to:

  • the portion of earnings generated following the partnership's breakup that the court may determine is attributable to his share of the assets.
  • five per cent annual interest on his portion of the partnership's assets.

(PA 1890, Section 42)

This is only the case if it can be demonstrated that the continuing partners have made money in relation to the departing partner's share.

This article is for information purposes only and should not be relied upon in place of legal advice.

© Melissa Worth, September 2022

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