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Feuding partners
Page 40
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Partnership law is rooted in Victoriana, so how do you resolve a 21st century fall-out between business partners? Nick Winters reports.
Many operators choose to run their businesses through partnerships nowadays — not least because the Limited Liability Partnerships Act 2000 extended the benefits of limited liability to limited liability partnerships.
However, the impact of a major dispute between partners cannot be underestimated. In general,the smaller the partnership, the greater the negative impact of a partnership dispute on the business and the more embittered the dispute becomes. This is probably because larger partnerships are more likely to have agreed procedures to deal with circumstances which could cause disputes.
Crucial structures
A well-structured partnership agreement is the best way to prepare for any issues that arise between partners. It enables them to agree procedures to be applied if potentially contentious situations arise.
In the event of any dispute, the partnership agreement enables the route to resolution to be set out. This will encompass the voting requirements for different categories of partnership decision and will usually specify how any residual grievances should be dealt with There is, however, no requirement for partners to have a formal written agreement. If no formal partnership agreement exists then, in the event of a dispute, the Partnership Act 1890 is the main legislation that would be relevant New partners need to understand that PA 1890 prescribes: • An equal sharing of profits and • That any difference arising that is to do with ordinary matters may be decided by a majority of the partners, but no change may be made in the nature of the partnership business, or another partner admitted, without the agreement of all partners.
The input problem
Equality is still the most common form of profit sharing arrangement in the smaller partnership. This can work very successfully when all partners trust each other and value their respective inputs into the business.
The partners need to consider how differing input might be dealt with. Unfortunately, there is no easy way to define how profits should be shared between partners in different circumstances. In most cases the solution will be a combination of reward based on financial contribution and recognition of management and business development input.
The practical problem for the smaller partnership is that non-financial input is difficult to measure. A common solution is for the first tranche of profit to be shared on an equal basis, with a second tranche of profit share based on relative financial contribution.
A number of benefits are achieved by the partners agreeing in advance and stating in a partnership agreement how profit share should be dealt with. Among other things this: • Encourages the partners to accept that, during the life of any partnership, it is quite usual for partners to contribute to the business in different ways and with differing levels of respective input.
• Forces the prospective partners to sit down together and discuss a difficult issue. If they cannot agree how varying input should be rewarded, then this highlights that they should reconsider whether partnership is the correct route for them.
• Minimises the likelihood of future dispute if a profit share method is agreed by everyone concerned at the outset.
• Allows this initial outline framework for sharing profits to be revisited in future years if it proves necessary.
The output problem
Another prime cause of partnership dispute is one or more partners drawing out more from the business than their profit share permits, or more than their fellow partners.
A number of steps can be taken, within the partnership agreement or in the general management of the partnership, to minimise the likelihood of a dispute being triggered by excess drawings: • Set conservative drawings levels for the partners that are linked to profitability. These can use a formula based on anticipated profit levels less taxation and a contingency reserve just in case things go wrong.
• Ensure that the partners have regular financial management information so that any possibility of excess drawings can be identified and corrected at the earliest opportunity.
• Ensure that the partnership retains sufficient funds to meet both partners' business taxation liabilities and that these can be paid out of retention of historic profits as opposed to an anticipation of future profits, which may not materialise.
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• Incorporate interest on partnership capital within the profit sharing arrangements so the partners with the greater financial interest in the business are appropriately rewarded and overdrawn partners are penalised. •