Partnership disputes: Why a Partnership Agreement is essential

Partnership disputes: Why a Partnership Agreement is essential

Rachel Armstrong, Dispute Resolution

When disputes arise between business partners, the starting point for resolving the dispute generally depends on whether there is a partnership agreement in place.

What is a Partnership Agreement?
A partnership agreement is a legally binding contract that outlines each partner’s rights, responsibilities, and obligations. It governs the relationship between partners and will usually include provisions relating to financial decisions, partner duties and the process for joining or leaving the partnership.

Whilst a partnership agreement is not a legal requirement of a partnership, it is highly recommended to have a formal written agreement in place.

An agreement that has been specifically prepared for a partnership can help to ensure the business operates on terms that have been agreed by the partners rather than relying on default terms that may not reflect the partners’ intentions. This is critical when disagreements arise.

What happens if there is no Partnership Agreement?
If no normal written agreement exists, the partnership will be governed by the default provisions of the Partnership Act 1890. The Partnership Act contains various provisions that may not be suitable for a business, such as equal sharing of profits and losses regardless of investment; automatic dissolution of the partnership if a partner leaves, dies or becomes bankrupt; and the requirement for unanimous consent to make certain decisions.

The Partnership Act may not provide the protection that a modern business requires. This can lead to complicated and costly situations arising when there is a disagreement between business partners.

Common reasons why a partnership dispute may arise
Partnership disputes are likely to arise when personal relationships breakdown, but they can also arise as a result of financial tension, an imbalance of power or strategic differences.

Some common reasons why disputes arise in the context of a partnership include:

• Financial disagreements
• Imbalance in effort or contribution to the business
• Strategic disagreements over the direction of the business
• Decision-making and authority conflicts
• Breach of fiduciary duties
• Admission or removal of partners
• Partner exits and buyout decisions

Clarifying expectations in a formal written document at the outset can help avoid misunderstandings further down the line. Many partnership disputes stem from a lack of clarity, meaning that what may start out as a simple misunderstanding can develop into a serious legal and financial conflict.

Of course, disputes cannot always be avoided. But careful planning, clear communication and a well-drafted partnership agreement can help to reduce the risk of a dispute arising, or the severity of one if it does.

Benefits of having a partnership agreement in place
Discussing the terms of a partnership agreement at the outset, while relationships are still positive, can help to iron out early misunderstandings before it is too late. A well-drafted agreement can help prevent disputes by providing clarity on key aspects of how the business is ran – some key points to consider are set out below.

1. Precise financial arrangements: Financial disagreements are the cause of many partnership disputes. It is essential that the way in which the partners intend for profits and losses to be shared is clearly stated in the agreement as, in the absence of any such clarification, profits and losses will be shared equally regardless of each parties’ level of investment.
2. Set clear expectations from the outset: A partnership agreement should clearly define each partner’s roles and authority. This can help avoid ambiguity around who is responsible for different tasks and who can make certain decisions.
3. Clarify decision-making procedures: The agreement should specify which matters (if any) require unanimous consent, which decisions require a majority vote and what will happen in the event of a deadlock situation.
4. Specific exit provisions: A well-drafted agreement will address what should happen when a partner wishes to leave or retire from the partnership, as well as in the event of the death or incapacity of a partner. The default provisions that apply in the absence of such clarification would result in the partnership automatically being dissolved, which is likely not the desired outcome of many businesses and could lead to significant disagreement between partners.
5. Provide guidance on dispute resolution: It is good practice to include alternative dispute resolution provisions in the partnership agreement. The terms, which can be agreed on by the parties at the outset, may include mandatory negotiation periods as well as mediation and/or arbitration clauses which provide a less adversarial and costly approach to dealing with a dispute than litigation.

How we can help
Our Dispute Resolution Team has extensive experience in dealing with a variety of partnership disputes. We offer clear, pragmatic advice tailored to your individual circumstances. If you would like advice in relation to a partnership dispute, or would like to discuss ways in which you can protect yourself from such a dispute arising in the future, please get in touch.