The importance of partnership agreements and documenting the arrangement.
A common form of conducting business in Australia is by way of a partnership. A partnership is commonly defined as two or more people conducting business together with a view to making a mutual profit.
Whilst it is not strictly necessary to have a formal partnership agreement, it is highly recommended. Irrespective of whether a partnership agreement exists, the Partnerships Act 1891 (“the Act”) apply.
The reason a written partnership agreement is so important is because it allows the partners to avoid certain aspects of the Act. For example, section 33 of the Act says that the death or insolvency of any one partner, in the absence of a partnership agreement which says otherwise, automatically dissolves the partnership.
Whilst that is understandable in circumstances where two people are in partnership, it is potentially a very disruptive and costly result if more than two people are in partnership and the surviving or solvent partners wish to continue in partnership with each other.
"With a partnership agreement in place, an exiting or expelled partner may have the terms of their exit agreed upon."
Equally important, a partnership agreement can set out how a partnership is to end. It is sometimes the case that partners who commenced a partnership on good terms no longer have agreement between them or some other conflict has arisen which requires a partner to leave the partnership or for the partnership to be dissolved entirely.
The Act is relatively strict about what is to occur in such circumstances. Broadly, in the absence of a partnership agreement, the partnership must pay out all of its creditors and liabilities and any funds remaining left over are then divided equally amongst the partners. Further, in the absence of a written partnership agreement, no majority of partners may expel a partner from the partnership.
With a partnership agreement in place, an exiting or expelled partner may have the terms of their exit agreed upon. For instance, it may be that their share in the partnership is paid to them over a period of time or that the continuing partners agree to assume liability for the exiting partner’s obligations in exchange for no payment being made. More importantly, the partnership can often continue without the need to revisit complex legal and accounting structures.
If there is a partnership agreement, it is important to record the exit of a partner properly. In particular, the accounting must be formalised and all adjustments made. For instance, the Act sets out that if a person has ceased to be a partner and the remaining partners continue the partnership business with its capital or assets and without any final settlement of accounts to the exiting partner then, in the absence of any agreement to the contrary, the outgoing partner may be entitled to a share of the profits made from the use of the partner’s share in the partnership assets, or to interest at the rate of seven per cent per annum on the amount of the partner’s share of the partnership assets.
In the event that you wish to form a partnership, or you are in an existing partnership which is likely to be dissolved or have a partner leave, it is important that you seek legal advice from a lawyer experienced in commercial and business law on how to adequately document that to protect your interests.