The simple notion of two or more people working together in business has spawned a dizzying array of legal vehicles through which such relationships can be mediated. Partnerships are a popular and important part of the business landscape, yet an understanding of partnerships is often lacking compared with the many other vehicles through which business may be conducted.
Although the specific meaning of ‘partnership’ varies between jurisdictions, there is a fundamental near-worldwide consistency in the acknowledgement that, when people work together for a common purpose as partners, the law must recognise and respect that relationship.
Although there are businesses of all kinds that use partnerships, it is true to say that partnerships have most enthusiastically been adopted (and in some jurisdictions, are the only vehicles permitted to be used) by professional services businesses, such as lawyers, accountants and doctors. Various flavours of partnership have also been the bedrock of much of the financial services sector, with limited partnerships in particular finding favour in this area. Outside of these sectors, businesses as diverse as rock bands, restaurants, farms and football clubs are often run through partnerships.
Choosing to adopt a partnership rather than a corporate model typically offers partners far greater freedom than is found in companies as to how and when the participants choose to divide profits and require capital to be invested, and how they allocate votes and management roles. This freedom to define a partnership’s constitution by agreement, rather than being constrained by statute, is among the most appealing aspects of the partnership and is one of the reasons for its success as a model.
However, this freedom does have the potential to create traps for the unwary. It is easy for partners to agree on the unrealistic or to fail to recognise that their agreement goes against their interests. For example, whereas companies are prohibited from paying dividends that exceed their profits, partners in many jurisdictions have no such prohibition and may find that they have drawn too much cash in anticipation of profits that do not in the event materialise, thus owing money to their firm and, ultimately, its creditors. This may come as a particular surprise to those who are in a partnership without meaning to be. Unlike a company, a partnership need not always be formally registered before it comes into being. Given such pitfalls, it is critical that partners and partnerships are well advised from the outset to avoid accumulating future problems.
This work focuses on the legal aspects of the various types of partnerships around the world, but advisers in this area need also to bear in mind the culture and ethos that a partnership engenders when considering how best to advise. Although limited liability status is now available for many forms of partnership, the traditional partnership is one in which partners are jointly and severally liable for the debts and liabilities of the business and each partner is capable of binding the other partners to such obligations. This mutual responsibility imposes a very high standard of behaviour on partners towards one another, which is reflected in the law of many jurisdictions.
Advisers often find, even in limited liability partnerships (LLPs), that expectations as to personal conduct and behaviour are of a higher standard than is often the case in other business vehicles. Whereas one might expect a shareholder to think only, or at least primarily, of his or her own interest, there is a notion that, in a partnership, each partner must act in all respects for the benefit of the other partners rather than for himself or herself alone.
In most jurisdictions, there is no upper practical limit on a partnership’s size. As partnerships have grown, sometimes with partners numbering in the hundreds or even thousands, the partnership ethos necessarily changes. A collegiate group comprising a small number of individuals will need to adopt a more corporate culture once the firm reaches a certain size. The flexibility of partnerships allows the centralisation of power to a single management board, much like a company’s board of directors.
Although the traditional partnership offered little or no protection to partners from their creditors, governments across the world have moved towards offering various forms of limited liability partnership. The quid pro quo for limited liability varies from place to place, with some jurisdictions, such as the United Kingdom, requiring public disclosure of financial information, whereas others, such as some US states, only limit certain types of liability and prohibit their use, save by certain professions. For many partners, the reduced personal risk makes these compromises a price worth paying.
The United Kingdom is home to one of the more unusual forms of LLP, which has been copied by some other jurisdictions, such as Gibraltar, in that an English LLP is a body corporate separate from the partners, yet its constitution can be arranged much as a traditional partnership would be and it is taxed in the same way as a partnership. This hybrid structure may prove to be popular, but in other jurisdictions, such as Jersey and many jurisdictions in the United States, the LLP is much closer to a typical general partnership. Whether the English LLP represents a path for the future or will stand alone remains to be seen. For advisers, such hybrid models require a working knowledge of both company and partnership law to understand the rights and obligations they give rise to in any particular scenario.
Whatever the precise form of LLP a jurisdiction provides (if any), the availability of LLP status has led to the conversion of many partnerships to LLP. It may prove hard to communicate to clients the need to have a substantially different constitution when changing status from partnership to LLP. It is not unheard of for LLPs to have used an unmodified partnership agreement as a constitution, resulting in a nasty shock on the LLP’s insolvency. The provisions in a partnership agreement by which the partners are to share losses, for example, have the potential, in the context of an LLP, inadvertently to disapply by contract the limitation of liability enjoyed by the members. Although the personal risks of partnership are lessened by LLPs, the need for competent professional advice is not.