Traditional partnerships .pdf

Partnerships This element covers how traditional partnerships are formed and used; the liability of partners and the relationship between the firm and outsiders. Taxation of partnerships is also covered. The use of partnership agreements is covered in the next element. Introduction Traditional partn...

Partnerships This element covers how traditional partnerships are formed and used; the liability of partners and the relationship between the firm and outsiders. Taxation of partnerships is also covered. The use of partnership agreements is covered in the next element. Introduction Traditional partnerships are governed by the Partnership Act 1890 (‘PA 1890’). A traditional partnership is very easy to establish. No formality is required because a partnership is defined simply as a relationship between persons carrying on a business in common with a view to making a profit (s 1(1) PA 1890). Sometimes partners may in fact be unaware that a partnership has arisen, where individuals have not taken legal advice and have started a business together. Other individuals will seek legal advice prior to commencing their business and will ensure that a detailed partnership agreement is drafted in order to regulate the business and affairs of the partnership. A partnership is NOT a legal entity separate from the partners themselves. The nouns ‘partnership’ and ‘firm’ are terms used to refer to all the partners collectively. There must be at least two persons to form a partnership. The PA 1890 does not distinguish between actual and legal persons, so a company could be a partner. Note that the term 'partnership' usually refers to a traditional partnership. Limited liability partnerships are referred to as 'limited liability partnerships' or 'LLPs'. Formation of partnerships There does not have to be any intention on the part of the parties to be, or form, a partnership. A partnership arises if, on the facts, the criteria in s 1(1) PA 1890 are met. Section 2 PA 1890 contains a list of rules for determining the existence of a partnership. The purpose of s 2 is to provide more detailed guidance in determining if the criteria in s 1(1) PA 1890 have been met. For example: • Evidence of profit sharing will be prima facie evidence of a partnership but not necessarily conclusive evidence (s 2(3) PA 1890). Case law provides that if there is an agreement to share losses as well as profits, this makes the existence of a partnership more likely. • If all individuals take part in decision making, this also makes it more likely that a partnership will be held to exist. • A loan of money by one party to another does not create a partnership. Case law has also held that if the person is not being ‘held out’ as a partner this makes the existence of a partnership less likely. Remember: Whether a partnership actually exists will be determined on the facts. Use of partnerships In practice, you will sometimes find that clients ask for your help to avoid creating a partnership, rather than asking you to create one for them. One reason is that the legislation governing partnerships, the PA 1890, is over 130 years old. The default provisions which are implied by that legislation are often unsuited to the modern business environment. In addition, clients will have concerns about being subject to unlimited liability. Nevertheless, there are advantages to partnerships. For example, it costs nothing to create a partnership, because absolutely no formality is required. There are also no required formalities for running a partnership and no filing or disclosure requirements, in contrast to companies which are heavily regulated. Conducting business through a partnership therefore allows for a high degree of confidentiality regarding the business’s affairs. There are almost as many partnerships in the UK as there are companies and many of them are professional partnerships such as lawyers, accountants, surveyors and architects. Many businesses start as partnerships before they convert to a limited company. Relationship of partners to one another: Fiduciary relationship There is an overriding duty of good faith in a partnership. The duty owed by the partners to one another is similar to that owed by a trustee to a beneficiary. These equitable principles are reflected in the following sections of the PA 1890: · Honest and full disclosure (s 28 PA 1890) · Unauthorised personal profit (s 29(1) PA 1890) · Conflict of duty and interest (s 30 PA 1890) Personal liability for partnership debts Because a partnership has no separate legal personality from the partners, the partners are personally liable in relation to contracts which are binding on the firm. The PA 1890 contains provisions relating to the nature and extent of such liabilities. In some circumstances, non-partners can also become personally liable. Nature of partners’ liability (ss 9, 10 and 12 PA 1890) Contractual liability Every partner in a firm is liable jointly with the other partners for all the debts and obligations of the firm incurred whilst they are a partner (s 9 PA 1890). Tortious liability In tort the partners’ liability is joint and several (ss 10 and 12 PA 1890). Liability of non-partners: new partners (s 17 PA 1890) Under s 17(1) a new partner will not automatically be liable in relation to any debts incurred by the partnership before they joined. Under s 17(2) a partner will still be liable after they retire in respect of debts incurred by the partnership whilst they were a partner. In order to relieve a partner from an existing liability once they retire, a partnership may novate the relevant agreement; this must be with the consent of the creditor (s 17(3)). Liability of non-partners: former partners (s 36 PA 1890) It is also possible for a former partner to become liable for partnership debts incurred after they have left. If a partner leaves, a third party can treat all apparent partners of the firm (ie before the departure) as jointly liable to pay any new debt incurred by the partnership UNLESS that third party has been notified of this change either by: • actual notice (s 36(1) PA 1890) - for those who have had actual dealings with the partner before departure; or • constructive notice by virtue of publication of the departure in the London Gazette (s 36(2) PA 1890) -for those who have not had actual dealings with the partner before departure. However, a former partner will not be liable for debts to any third party who did not know them to be a partner before they left. No notice at all has to be given to such persons. Liability of non-partners: ‘holding out’ (s 14 PA 1890) Generally, a person who is not a partner has no personal liability for partnership debts. However, s 14 PA 1890 sets out circumstances where a non-partner may be personally liable on a partnership debt if they have held themselves out as a partner (or have knowingly allowed themselves to be so held out). The elements required for s 14 PA 1890 to have effect are: (i) a representation to a third party to the effect that a person is a partner, (ii) the third party's action in response (‘giving credit to the firm’, eg by supplying goods or services to the firm), and (iii) the third party's state of mind (‘believing (having faith in) the representation’). It is important to appreciate that s 14 PA 1890 relates to the liability incurred by the NON-PARTNER, not the liability of the firm. The liability of the firm for the acts of a non-partner is established by applying the common law principles of agency. The relationship between the firm and outsiders: contracts binding the firm In practice, you may need to decide whether or not the partnership is bound by a contract which an individual has purported to make on its behalf. In a partnership context, your approach to answering the question of whether or not a firm is bound by a particular contract will differ depending on whether the individual acting on the firm’s behalf is a partner or not. Partners Section 5 PA 1890 introduces a special statutory rule of agency which applies only when the agent in question is a partner in the firm. The common law of agency may also apply where s 5 is not relevant. Non-partners The common law of agency will apply. Section 5 PA 1890 does NOT apply. 1. Partners content with agent's act (whether partner or non-partner) In many cases, an individual acting as a firm's agent (whether a partner or not) will simply have put into effect the wishes of the partnership as a whole. If all the partners are happy for the firm to enter into the contract and have given actual, express or implied authority to bind the firm, then the firm will be bound. In any event, if the partners are happy to be bound, the situation is not problematic even if the agent had no authority at the time the contract was made. The partners are able to ratify (ie approve) the agent's act and adopt the contract, either expressly or simply by going ahead and performing it. 2. Partners not content with agent’s act The situation is more complex where the other partners are not content with the agent’s act. (a) Power of a partner to bind the firm against the others' wishes: s 5 PA 1890 Section 5 PA 1890 provides for the firm to be bound in certain circumstances, even where the other partners are not happy to be bound by the contract made by the agent. Since s 5 PA 1890 is intended to protect the third party to the contract, it is that third party's view of what is happening that counts. Section 5 PA 1890 is always the first place to look when deciding whether or not an act of a partner binds a firm but does not displace the application of ordinary common law agency entirely. In some circumstances, s 5 PA 1890 alone will not get you to the end of the story. If a partner has purported to form a very unusual kind of contract on behalf of the firm, a s 5 PA 1890 analysis may lead you to conclude that the firm is not bound under statute. However, the particular facts and circumstances of the case may mean that this partner did have their partners' apparent authority at common law to conclude the contract. Following s 5 PA 1890 a partner's unauthorised act will bind the firm if, viewed objectively: • the act is for carrying on businessof the kind carried on by the firm (ask, for example, ‘is this the kind of contract that one would expect to be entered into in the course of business of this kind?’); and • the act is for carrying on such a business in the usual way (ask, for example, ‘is this the kind of contract that a partner acting alone would usually make on the firm's behalf or is it a contract of the kind an outsider would expect all partners in a firm to sign individually?’). The firm will not be bound, however, if: • the third party actually knew that the partner in question was not authorised to enter into the contract on behalf of the firm; or • the third party did not know or believe that the partner was a partner. A partner who binds their firm without actual authority may be liable to the other partners for breach of contract. (b) Power of a non-partner to bind the firm against the partners' wishes: apparent authority at common law Section 5 PA 1890 does not apply at all if the person entering the contract is not in fact a partner. In that case, the common law rules of agency establish whether or not the firm is bound as principal. At common law, an agent who has no actual authority may still bind the firm if he has apparent authority to enter into a contract. Apparent (sometimes called ‘ostensible’) authority arises when the principal (here the firm) represents or permits a representation to be made to a third party that a person has authority to bind the firm. For example, if a firm employs somebody under the title ‘marketing manager’ that title confers on that person apparent authority to bind the firm on marketing decisions. Once the principal's representation has been made to, and relied upon by, the third party, the principal is bound by the actions of that person. If the representation is that a particular person is a partner (when, in fact, they are not), then the firm is said to be ‘holding out’ that person as a partner. A person who has been held out as a partner has apparent authority to bind the firm in the same way as a real partner can. An example of holding out is in relation to an ex-partner, when the firm carries on using old letterhead (including that partner’s name) after they retire. Taxation of Partnerships Each partner is liable to tax as an individual on their share of the income or gains of the partnership. This is described as tax transparency. Even though a partnership is not a distinct legal entity and therefore does not itself pay tax, HMRC requires a partnership to make a single tax return of its profits which must be agreed with HMRC (as with sole traders, partnerships choose their own accounting period). Partners also submit their own individual tax returns containing all income received from the partnership as well as other income receipts (including, for example, from savings, dividend and/or rental income). Partners in a partnership are liable to pay both income tax and capital gains tax. The details are set out on the next slide. Taxation of Partnerships Income tax: Each partner is personally liable for the income tax on their share of the partnership profits. Unlike with other partnership liabilities where each partner is jointly and severally liable, a partner is not liable for the tax on other partners’ shares of partnership profits. Capital gains tax: Normal capital gains tax principles apply on disposal of a capital asset by a partnership. Each partner is treated as owning a fractional share of the asset. On disposal by the partnership, each partner is treated as making a disposal of their share and will be taxed on this share of any gain, subject to the availability of any reliefs available to individuals. A partner’s fractional share shall be based upon the agreed PSR or, if there is no agreed PSR, then equally in accordance with s 24(1) PA 1890. Summary • A partnership can be formed without any legal formality. Furthermore, a partnership can be formed even without the specific intent of the parties to form one. • Partnerships are governed by the Partnership Act 1890. • Partnerships are NOT a separate legal entity to its partners. • Partners in a partnership have joint liability in contract, and joint and several liability in tort. • When determining whether the firm is bound, s 5 PA 190 applies when a contract is purportedly formed by a partner. The common law of agency will apply if the person in question is not in fact a partner. • Conducting business through a partnership allows for a high degree of confidentiality regarding the business’s affairs. • Partnerships are tax transparent: the partners themselves pay income tax and capital gains tax on their share of profits and gains.