Partnerships are one of the key mechanisms by which two or more parties can form a legal basis for jointly managing and operating a business, and sharing in its profits. These arrangements can be highly beneficial if they are understood and used correctly by the partners involved.

Broadly, there are two types of partnership: a traditional partnership and a limited liability partnership (LLP).

• A traditional partnership exists when two or more individuals wish to conduct business to make a profit. A traditional partnership is not a legal entity, and therefore the partners’ liability is unlimited.
• An LLP also exists when two or more individuals wish to conduct business to make a profit, but unlike a traditional partnership, an LLP is a corporate body and a defined legal entity. An LLP may enter into contracts, hold property, and can sue or be sued; additionally, the members of an LLP have a limited liability, which makes an LLP attractive to partners.

Partnership agreement

When partners enter into a partnership agreement, this is done via a private document that is not available for public inspection or scrutiny. The partnership agreement is negotiated between the members of the partnership about how the partnership will be run, and will usually include:

• Financial information
• The procedure by which the managing partner is to be elected
• Voting rights of members
• The process for which partners may retire or be expelled
• Practical information such as holiday entitlement.

Liability

A traditional partnership is not a legal entity, and the liability is unlimited. In practice, this means that if a partnership is sued, it is actually the individual partners who are being sued. Similarly, if the partnership goes into debt, because it is not a legal entity the debt will be owed by the individual partners.

An LLP is a legal entity, and therefore an LLP can be sued and the liability of the LLP members is limited, which means the LLP members are not being individually sued and would not be required to pay any damages from their own pocket. Any debts would be in the name of the LLP, rather than the individual LLP members. 

What happens if a partner is in breach of the partnership agreement?

If a partner has breached the partnership document, a legal claim for breach of contract may be brought by the other partners. 

Some partnership agreements may contain arbitration clauses, which means that a dispute may be able to be resolved without legal proceedings.

Unfair prejudice

It is possible for members of an LLP to unanimously agree in writing to exclude unfair prejudice in the partnership agreement. Unfair prejudice may exist when the LLP or its members are acting (or propose to act) in a manner that is unfairly prejudicial to the interest of members generally, or individual members.

If the partnership agreement doesn’t include specific rules in the contract to exclude unfair prejudice, members of a partnership will be entitled to make an application to the court, if they believe their rights are being unfairly prejudiced by other members of the LLP.

Leaving a partnership

Generally, a member of a partnership may retire from the partnership upon death, under agreement with other members, or by giving reasonable notice.

A member may only be expelled from the partnership if expulsion has been agreed between members. Excluding a member without agreement in the partnership agreement may result in a breach of regulation 8 of the Limited Liability Partnership Regulations 2001. 

Fiduciary duty

Members of an LLP owe the same fiduciary duty that directors owe to a company. This means that members of an LLP have a duty to act in good faith, and in the best interests of the LLP and its members.

It is a breach of fiduciary duty for the members of an LLP to enter into a retirement deed of a member at the time when the LLP is insolvent. If there is a breach of fiduciary duty by a member, they risk having to forfeit their share of remuneration and profits, in addition to having to pay damages.