2 - Partnerships and LLPs

Question 1

What is a Partnership?

Answer 1

A relationship between two or more persons carrying on a business in common with a view to making profit. The PA 1890 does not distinguish between actual and legal persons, so a company can be a Partner.

There does not have to be intention on the part of the parties to be, or form, a partnership

It is NOT a legal entity separate from the partners themselves.

Whether a partnership exists will be determined on the facts.

Question 2

Which rules determine the existence of a partnership?

Answer 2

Section 2 PA 1890:

• Evidence of profit sharing will be prima facie evidence of a partnership. Case law shows that an agreement to share losses as well as profits increases the likelihood of a partnership.
• If all individuals take part in decision making, this makes it more likely that a partnership exists.

Less likely:
- A loan does not create a partnership.
- If not being ‘held out’ as a partner, a partnership is less likely.

Question 3

Advantages and disadvantages of partnerships

Answer 3

Advantages:

• No formality is required to create or run a partnership.
• Cost-effective: Partnerships cost nothing to create compared to companies.
• Confidentiality: No filing or disclosure requirements allow for greater privacy in business affairs.
• Flexibility: Fewer regulatory obligations compared to companies.

Disadvantages:

• Unlimited liability: Partners are subject to unlimited liability for business debts, which can be a significant concern.
• Outdated legislation: The governing law, PA 1890, is over 130 years old and its default provisions are often unsuited to modern business needs.
• No limited liability protection: Unlike companies, partners risk their personal assets in case of business failure.

Question 4

What relationship and duties do partners have to one another?

Answer 4

There is an overriding duty of good faith in a partnership, reflected in the PA:
- Honest and full disclosure (s28)
- Unauthorised personal profit (s29)
- Conflict of duty and interest (s30)

Question 5

What type of liability do partners have in relation to partnership debts?

Answer 5

Personal liability: Partners are personally liable for contracts binding the firm because a partnership has no separate legal personality.

Contractual liability (s 9 PA 1890): All partners are jointly liable for debts and obligations incurred by the firm while they are partners, e.g., overdue rent.

Tortious liability (ss 10 and 12 PA 1890): Partners are jointly and severally liable for torts committed by the firm. Each partner can be sued individually or together with others.

Civil Liability (Contribution) Act 1978: Even if one or more partners are sued, other partners remain liable, as liability is joint and several under this law.

Question 6

What is the liability of non-partners in a partnership?

Answer 6

New Partners (s 17 PA 1890):
New partners are not automatically liable for debts incurred before they joined (s 17(1)).
Retired partners remain liable for debts incurred while they were a partner (s 17(2)).
To discharge liability after retirement, a novation agreement with creditor consent is required (s 17(3)).

Former Partners (s 36 PA 1890):
A former partner may be liable for new debts unless third parties are notified of their departure.
Actual notice is required for those who had prior dealings with the partner (s 36(1)).
Constructive notice (published in the London Gazette) is sufficient for those who did not have prior dealings (s 36(2)).
No liability exists for third parties who did not know the former partner prior to departure.

Question 7

What is the liability of non-partners under the ‘holding out’ principle (s 14 PA 1890)?

Answer 7

Under s 14 PA 1890, a non-partner can be personally liable for partnership debts (not the firm) if they are “held out” as a partner. The required elements are:

1. Representation: A non-partner represents themselves or knowingly allows themselves to be represented as a partner.
2. Third Party Action: A third party provides credit to the firm (e.g., supplying goods or services) based on that representation.
3. Third Party Belief: The third party believes in the representation that the person is a partner.

Question 8

How is the partnership bound by contracts made on its behalf by partners and non-partners?

Answer 8

Partners: Under s 5 PA 1890, partners are treated as agents of the firm and can bind the partnership by contracts made on its behalf. The common law of agency also applies if s 5 is not relevant.

Non-partners: The common law of agency applies, but s 5 PA 1890 does not. The partnership may only be bound if the non-partner had authority under agency law principles.

Question 9

What happens if the partners in a partnership are content with an agent’s actions, regardless of their authority at the time?

Answer 9

If all partners are content with the contract entered into by an agent (partner or non-partner) and have given actual, express, or implied authority, the firm will be bound.

Even if the agent lacked authority at the time, the partners can ratify the agent’s act and adopt the contract by either expressly approving it or by performing it.

Question 10

Under what conditions can a partner bind the firm against the other partners’ wishes under s 5 PA 1890?

Answer 10

Under s 5 PA 1890, a partner’s unauthorised act will bind the firm if:

• The act is for carrying on the kind of business the firm usually conducts.
• The act is for carrying on business in the usual way.

However, the firm will not be bound if:

• The third party knew the partner lacked authority.
• The third party did not know or believe the person was a partner.

A partner who binds the firm without authority may be liable to the other partners for breach of contract.

Question 11

How can a non-partner bind a firm against the partners’ wishes under the common law rules of apparent authority?

Answer 11

At common law, a non-partner can bind a firm through apparent (ostensible) authority if:

• The firm (principal) represents or permits a representation to a third party that the person has authority.
• The third party relies on that representation.

E.g., Holding out a non-partner as a partner, such as by continuing to use their name after they leave the firm.

Question 12

How are Partnerships taxed?

Answer 12

Tax transparent: Each partner is taxed individually on their share of partnership income or gains. The partnership itself does not pay tax but must submit a single tax return to HMRC.

Income Tax: Each partner is personally liable for tax on their own share of profits. No joint/several liability for other partners’ tax.

Capital Gains Tax: Partners are treated as owning a fractional share of assets. On disposal (sale, transfer or exchange of the asset), each partner is taxed on their share of the gain. Fractional share based on the Profit Sharing Ratio (PSR - ratio agreed by partners), or equally if no PSR is agreed (s 24(1) PA 1890).

Question 13

What does the Partnership Act 1890 (PA 1890) cover and how can its provisions be altered?

Answer 13

Provides default rules for partnerships. Statutory provisions are really ‘fall-back’ provisions in the absence of a partnership agreement, or where the agreement is silent on any matter.

Partners can alter statutory provisions with their own partnership agreement. Changes require unanimous, and this can be express or inferred from a course of dealing. (s 19 PA 1890).

Most traditional partnerships will have a formal written partnership agreement, which will set out the terms on which the partners have agreed to run the business and override default rules contained within the PA.

Question 14

What should be included in a partnership agreement regarding commencement and duration, and what is the role of the Partnership Act 1890 (PA 1890) in these aspects?

Answer 14

Commencement Date: Define when the agreement’s terms start. If partners work together before this date, the default provisions of PA 1890 apply.

Term: Can be fixed or indefinite; if a fixed term ends but business continues without a new agreement, the same terms are presumed (s 27 PA 1890).

Question 15

What are the requirements for a partnership name and what should the agreement include about the place of business?

Answer 15

Must not include ‘limited,’ ‘ltd,’ ‘LLP,’ ‘plc,’ be offensive, duplicate a trademark, use sensitive words, or imply government affiliation without permission.

Place of Business: Specify the business location and nature of the business in the partnership agreement.

Question 16

How is partnership property defined and handled under PA 1890?

Answer 16

Definition: All property brought into the partnership for its purposes or bought with partnership funds is deemed partnership property (ss 20-21 PA 1890).

Partnership Agreement: Should specify which assets are considered partnership property to avoid disputes, as ownership is based on the intentions of the partners.

Default Provisions (PA 1890):
s 20: Property brought into the partnership or used for partnership business is partnership property.
s 21: Property purchased with partnership funds is presumed to be partnership property unless proven otherwise.

It is sensible for partners to agree which assets are partnership property to minimise the potential for dispute later.

Question 17

How are shares in income, capital, and profits determined under PA 1890, and what should a partnership agreement include?

Answer 17

Default Provision (PA 1890): Partners share equally in capital, profits, and losses, regardless of their capital contributions.

Profit Sharing Ratio (PSR): If partners wish to vary from the default, they should specify an express PSR in their partnership agreement.

Implication: Unequal capital contributions might imply an unequal withdrawal of capital but default sharing remains equal unless agreed otherwise.

Question 18

How are drawings and salaries handled in a partnership?

Answer 18

Drawings: The agreement should set out the amount each partner may draw periodically. By default, all partners share income profits equally (s 24(1) PA 1890).

Salaries: If partners are to receive a salary in addition to their profit share, this must be expressly stated in the agreement as the default is no entitlement to a salary.

Remuneration: Without an agreement a partner is not entitled to a salary.

Question 19

How are work input, roles, and authority limits addressed in a partnership?

Answer 19

Work Input: Under PA 1890, partners may participate in management but are not required to. The partnership agreement should specify each partner’s work requirements and expectations. Commonly, agreements require partners to dedicate their full time and attention to the business.

Roles and Authority Limits: The agreement should clearly define partners’ roles and any limits on their authority to ensure clarity and prevent disputes.

Management: Every partner may take part in the management of the partnership business.

Question 20

How should decision-making processes be addressed in a partnership agreement?

Answer 20

Default Rule: Ordinary business decisions are made by majority vote. Unanimous consent is required for changing the business nature, introducing new partners, or varying partners’ rights (s 24 PA 1890).

Partnership Agreement: Should clearly outline these decision-making processes and any exceptions.

Question 21

What does PA 1890 say about admitting new partners, and how should this be handled in a partnership agreement?

Answer 21

Default Rule: A new partner cannot join without the unanimous consent of all existing partners (s 24(7) PA 1890).

Partnership Agreement: It is advisable to include an express clause requiring written consent of all partners for a new partner to join the partnership, to avoid any doubt as to whether consent was in fact given.

Question 22

What provisions regarding the expulsion of partners should be included in a partnership agreement?

Answer 22

Default Rule: A partner cannot be expelled by majority vote unless all partners have previously agreed to this procedure (s 25 PA 1890).

Partnership Agreement: Should include clear expulsion provisions to allow for removal without dissolving the partnership.

Question 23

What happens if a partner leaves, and how should a partnership agreement address this?

Answer 23

Default Rule: The partnership is automatically dissolved if a partner leaves (s 26 PA 1890 automatic dissolution).
Note that if one partner leaves a partnership of two partners, the remaining “partner” becomes a sole trader.
In most cases, this is called a ‘technical dissolution’. This means that a new partnership is formed by the remaining partners who continue the business and does not lead to the winding up of the business.

Partnership Agreement: To prevent dissolution, the partnership agreement should state explicitly that the partnership will continue as between the remaining partners and should contain details of how a partner can leave, and specify arrangements for continuity or dissolution.

Question 24

How are non-compete clauses handled in a partnership agreement?

Answer 24

Default Rule: Partners, who carry on any business of the same nature as and competing with that of the firm, must account for profits from competing businesses (s 30 PA 1890).

Partnership Agreement: Should include clauses preventing partners from competing with the firm and, potentially, post-retirement restrictions to protect business interests. There are no such default clauses in PA 1890.
Incl, non-compete, non-solicit, and non-dealing clauses.

Question 25

How can a partnership be dissolved under PA 1890, and what should a partnership agreement include?

Answer 25

Dissolution Grounds: Can occur due to expiry of a fixed term, completion of a venture, death or bankruptcy of a partner, or notice of dissolution, or dissolution of partnership if it becomes unlawful, or dissolution by the courts (s 26, 32-34 PA 1890).

Partnership Agreement: Should outline when and how the partnership may be dissolved, including provisions for winding up the business and distributing assets.

Question 26

How are assets distributed upon the dissolution of a partnership?

Answer 26

Default Rule: After paying all debts and liabilities, any remaining assets are distributed by returning each partner’s original capital first (s 44(b)(3) PA 1890).

Surplus Assets:
With ASR: If an asset surplus ratio (ASR) is agreed, it governs the distribution of surplus assets.
Without ASR: Surplus assets are distributed according to the profit-sharing ratio (PSR) if agreed (s 44(b)(4) PA 1890).
No PSR: If there is no PSR, surplus assets are shared equally (s 24(1) PA 1890).

Partnership Agreement: Should detail how surplus assets are to be shared to avoid default provisions and ensure fair distribution.

Question 27

What is an LLP?

Answer 27

An LLP is a hybrid vehicle. It has elements of both a company (legally it is a body corporate and is treated as a separate legal entity from its members, can create a floating charge over its assets), and a partnership (it is treated as tax transparent).

It has the flexibility of a partnership with the added advantage of limited liability for its members. It has a legal personality which is separate from that of its members, and is liable for its own debts and is able to contract with third parties.

Question 28

What are the commercial uses for LLPs?

Answer 28

• Professional Partnerships: Commonly used by solicitors, surveyors, and accountants.
• Flexible Business Vehicle: Ideal for joint ventures, investment schemes, and venture capital investments due to its flexible structure.
• Investment Structures: Tax transparency of LLPs supports high member participation in management while providing limited liability.
• Property Development: Increasingly used by property developers for one-off joint venture development projects.

Question 29

How is an LLP formed?

Answer 29

Formation Requirements (s 2(1)(a) LLPA): Two or more persons (including companies) carrying on a lawful business with a view to profit.

Registration at Companies House:
Form LL IN01: Must be completed with details including the LLP’s name, registered office address, registered email address, and designated members (if applicable).
Submission: The form is sent to Companies House with the relevant fee.
Address Requirement: Must be an “appropriate registered address” since March 2024.
Restrictions and Compliance:

Disqualification: Individuals disqualified as directors cannot be LLP members.

Company Names and Identification Verification: Subject to ECCTA restrictions and identification verification requirements (not yet in force).

Certificate of Incorporation: Issued by the Registrar of Companies as proof of legal compliance. The LLP’s name and number are recorded on the company names index.

Question 30

Once registered, what information should an LLP continue to provide Companies House?

Answer 30

Change of Name, Change of Registered Office and Email, Changes in Membership, Creation of a Charge.
Annual Confirmation Statement: File yearly to confirm details are up to date.
Accounts: Submit accounts as per the Limited Liability Partnerships (Accounts and Audit) (Application of Companies Act 2006) Regulations 2008.

In-House Record-Keeping:
Registers: Maintain registers of members and ‘People with Significant Control’ (PSCs), who hold more than 25% interest or have significant influence/control over the LLP.

Question 31

Who are the members of an LLP?

Answer 31

Who Can Be a Member: Individuals or corporate bodies.
Minimum Members: At least two.
Maximum Members: No limit on the number.

Designated Members:
Requirement: Minimum of two designated members, whose responsibilities are to:
- Sign accounts.
- File documents at Companies House.
- Represent the LLP in the event of winding up.

Question 32

When will a member cease to be a member of an LLP?

Answer 32

Section 4(3) LLPA states that a member will cease to be a member of the LLP upon:

• Their death;
• Agreement with the other members of the LLP;
• Giving notice to the other members of the LLP; or
• Dissolution (if the member is a body corporate).

Question 33

What is an LLP Agreement and why is it needed?

Answer 33

• No Standard Documents: Unlike companies, LLPs do not have a Memorandum or Articles of Association. There is no statutory management structure prescribed by the LLPA or the 2001 Regulations.
• Flexibility: LLPs have complete flexibility in management. It is crucial for LLPs to have an LLP or Members’ Agreement to define management procedures and arrangements.
• Purpose of the Agreement: The LLP Agreement is a private document that outlines the formal procedures and arrangements agreed upon by the members for running the business.
• Requirement: While not obligatory, having a formal Members’ Agreement is recommended for regulating the relationship between members.

Question 34

In the absence of an LLP Agreement which regulations provide default provisions and what are they?

Answer 34

Default Provisions: In the absence of an LLP Agreement, the 2001 Regulations provide eleven default provisions (regulations 7 and 8) that apply.

1. Capital and Profits: Members share equally in capital and profits (Reg 7(1)).
2. Indemnity: LLP must indemnify members for liabilities incurred in the ordinary conduct of business (Reg 7(2)).
3. Management Participation: Every member can participate in management (Reg 7(3)).
4. Remuneration: No member is entitled to remuneration for managing the LLP (Reg 7(4)).
5. Membership Changes: No new member or assignment without consent of all existing members (Reg 7(5)).
6. Decision Making: Majority decisions for ordinary matters; unanimous consent needed for changes in business nature (Reg 7(6)).
7. Records Inspection: Books and records must be available for member inspection at the registered office (Reg 7(7)).
8. Disclosure: Members must provide full information affecting the LLP to other members (Reg 7(8)).
9. Competing Business: Members must account for and pay profits from competing businesses to the LLP (Reg 7(9)).
10. Transaction Benefits: Members must account for benefits from transactions with the LLP (Reg 7(10)).
11. Expulsion: No implied power to expel a member by majority; must be expressly provided for (Reg 8).

Question 35

How is an LLP taxed?

Answer 35

For tax purposes, an LLP is treated as a partnership.Partners are taxed individually on their share of the LLP’s income or gains. The LLP itself does not pay tax.

Reliefs: Members may access similar reliefs as partners, such as relief on interest or set off of losses.

Capital Gains: Assets held by the LLP will be treated as being held by the members as partners for capital gains tax purposes, and disposal will be regarded by HMRC as a disposal by the members of the LLP while it is trading.

The LLP itself may register for VAT, not the members.

Question 36

Is an LLP taxed for stamp duty?

Answer 36

Stamp Duty Relief: Available if a partnership incorporates as an LLP and transfers business assets, subject to conditions.

Transfer Taxes: Stamp duty or SDLT may be payable on the transfer of an interest in an LLP.

Question 37

What characteristics, similar to a partnership, does an LLP have?

Answer 37

• No Share Capital: LLPs do not require share capital.
  Unified Management: Members manage the LLP without distinct roles like shareholders and directors in companies.
• Flexible Agreements: Members can decide on profit sharing, management duties, decision-making, and other operational matters.
• Members’ Agreement: Functions like a partnership agreement, guiding LLP operations.
• Tax Transparency: Members are taxed individually on LLP profits, similar to a partnership.
• Clawback Rule: Money taken out of the LLP up to two years before insolvency can be reclaimed to pay creditors (s 214A IA).