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Partnership Perils and the Benefits of a Partnership Agreement

Written by Will Spisso, Associate

For most entrepreneurs, starting a new business is a time filled with excitement and optimism.  However, when people work together to start or operate a business, it can have the unintended result of forming a partnership.  Unfortunately, this often leads to disputes later on, especially if the business partners decide to part ways.

Forming a partnership is simple and can occur even if it is not the parties’ intention.  Under the Partnership Act of British Columbia, a partnership is defined as “the relation which subsists between persons carrying on business in common with a view of a profit.” No formal agreement is necessary to create the partnership.  If two or more people start working together on a business with the goal of making a profit, it is likely that a partnership will exist.  However, for the reasons discussed below, it is important that businesspersons do not enter into accidental partnerships. Also, if you intend to form a partnership, you can avoid serious pitfalls by entering into a partnership agreement.

A partnership is not a legal entity separate from its partners.  This means that a partner is personally liable to the full extent of his or her personal assets for the debts and obligations of the partnership.  If one partner enters into a contract, the other partners are also liable and required to perform all obligations under the contract in connection with the partnership business.  Furthermore, the partners are liable for the actions of the other partners.  For example, if someone sues the partnership, each partner will be fully and personally liable if the lawsuit is successful.  This is the case, even if only one partner was the cause of the lawsuit. 

Another feature of a partnership is that it can be dissolved almost as easy as it can be formed.  Unless otherwise stated in an agreement among the partners, the partnership can be dissolved by any partner giving notice to the others of his or her intention to dissolve the partnership.  This can create an incredibly difficult situation when one or more partners wish to continue with the business, while another partner wishes to exit and see the partnership dissolved. 

In addition to stopping a functioning business dead in its tracks, the dissolution of a partnership can also pose significant problems when it comes to dividing the partnership assets if there is no agreement in place identifying who the assets belong to.  By default, no partner has a right or entitlement to take specific assets that he or she may have contributed to the partnership.  Therefore, if a partner does not want a particular asset to become partnership property, this should be documented in an agreement among the partners.

The issues above highlight some of the most important reasons why it is recommended to have a partnership agreement.  In a partnership agreement, the partners can:

 

·        outline the roles of particular partners, including their duties and obligations;

·        state whether insurance is required for the partnership in respect of particular activities;

·        determine which partners may enter into contracts on behalf of the partnership;

·        set out how partnership assets will be divided upon the dissolution of the partnership;

·        establish what is required for the dissolution of the partnership; and

·        break down how partnership profits and liabilities will be allocated among the partners.

It is usually only once the business partners have a dispute or when one partner wants to leave the business that they finally approach a lawyer for advice.  At that point, however, the lawyer’s options may be limited to trying to help the parties negotiate and reach a compromise on how the dispute will be settled. If there is no partnership agreement in place, and one partner is set on dissolving the partnership, this can effectively end the business. 

Consequently, to avoid unnecessary disputes in a partnership, it is helpful to have a partnership agreement in place at the time the partnership is formed.  Though this may result in initial legal costs, it can save a great deal of time, money, and frustration later on when a dispute arises among the partners.  Moreover, if the business relationship does not work out, it can provide a clear roadmap for how the partnership will be dissolved and how its assets will be distributed.  Though this may not be the outcome the optimistic businessperson hoped for when starting the business, it can provide that same person the opportunity to move on and start again with an even better business endeavour.

 

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