Why formal partnership agreements protect a business if partners fall out

Business partnerships - often started through friendship or a close family relationship - are based on no more than a handshake or a gentleman’s agreement.

When business partners set up together they invariably get on well and rarely disagree about anything.

Michael Peacock, a partner at hlw Keeble Hawson specialising in Dispute Resolution, warns that disagreements do arise even amongst the closest of allies - and it is far easier to resolve them if the parties have agreed in advance just what will happen in such an event.

While the law will step in to provide a limited level of governance in circumstances when parties have no Partnership Agreement - courtesy of the provisions of the Partnership Act 1890 -  that act applies a broad brush approach which is not suitable for all partnerships.

Unless an informal arrangement is overridden by a formal agreement, there can be difficulties for some or all of the partners.

The precise terms of a Partnership Agreement depends very much on the nature of the partnership and the individual circumstances of its partners. However, the following considerations are usually relevant:

  • Decide at the outset what will happen if one partner wishes to leave. This is something often overlooked, but it is far better to put in place a mechanism for dealing with this at the start rather than waiting until a party wants out - particularly as it may be contrary to the wishes of the other partners, or as a result of a dispute with them.
  • The Partnership Agreement should spell out whether or not the partnership will continue with the remaining partner(s) and the terms upon which the existing partner will leave. For example, how much will he or she be paid for his share?  When will they be paid it?  Will they be permitted to set up a competing business immediately after the exit?
  • Set out any circumstances in which a partner can be forced by the other partner(s) to leave the partnership. For example, if his or her performance falls below a certain level.
  • Set out how the business will be run and managed. Who has the power to decide what?  Who has authority to sign cheques? Which decisions require unanimity? How will disagreements be resolved?
  • Identify what is expected of each partner. How much capital is to be contributed? If one partner is required to devote more time to the business than the others, is that partner going to be rewarded for this?  What happens if one partner doesn’t pull their weight? Unless specific provision is made, all profits and losses are shared equally, irrespective of how much time each partner devotes to the business.

Whilst a Partnership Agreement will not necessarily prevent a dispute arising, it will often save a considerable argument - and money - if a fall out occurs.