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Partnership
Contents
Introduction
Examination context
Topic List
1 Ordinary partnerships
2 Comparison between ordinary partnerships and companies
3 Limited liability partnerships
Summary and Self-test
Answers to Self-test
Answers to Interactive questions
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Introduction
` To define partnership
Practical significance
Businesses should ensure that they are run in the most efficient and appropriate manner. Part of this is
assessing whether to operate as a partnership or a registered company. Limited liability is attractive, but
usually brings with it a more onerous burden of regulation and administration. A limited liability partnership
may be an attractive option for some businesses. Like your clients, the firm you work for may also need to
assess how it operates. Accountants have traditionally worked together in partnerships, but recent years
have seen them increasingly finding ways of limiting their potential liabilities (which we touched upon in
Chapter 4).
Working context
Not only might you be working for a partnership, you may find your firm numbers partnerships among its
clients as well. As a business adviser, you could well find yourself advising a client on the advantages and
disadvantages of partnership or incorporation as a limited company or limited liability partnership.
Syllabus links
The practical effects of partnership will be relevant when looking in detail at audit firms and their liability in
the Audit and Assurance paper.
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Examination context
Exam requirements
Partners' authority will be examined in the context of agency law, commonly in a scenario question. The
law on partnerships may also be examined by requiring a comparison with companies.
In the assessment, candidates may be required to:
` Identify the differences between partnerships and companies
` Recognise the authority a partner has to enter into contracts on behalf of the partnership
` Identify the procedure required to form a limited liability partnership and the administrative
consequences
Identify the rights and duties which a member of a limited liability partnership possesses.
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1 Ordinary partnerships
Section overview
` A partnership is 'the relation which subsists between persons carrying on a business in common with
a view of profit'.
` A partnership can be an informal arrangement or it can be formalised and regulated by a written
partnership agreement.
` A partnership can be termed an 'ordinary' (or traditional) partnership in order to distinguish it from a
limited liability partnership (see section 3 below).
` The Partnership Act 1890 governs ordinary partnerships.
Partnership is a common form of business association. It is flexible, because it can be either a formal or
informal arrangement, thus suiting both large organisations and small operations.
Most professions prohibit their members from carrying on practice through limited companies and
therefore operate as partnerships. However some permit their members to trade as 'limited liability
partnerships' which share many characteristics with companies (and which are described in section 3 of this
chapter). Businessmen are not so restricted and generally prefer to trade through a limited company for the
advantages this can bring.
1.1 Definition
A partnership is 'the relation which subsists between persons carrying on a business in common with a view
of profit' (s 1 Partnership Act 1890). This definition can be further explained as follows:
Relation which subsists A partnership does not have a separate legal personality, it is merely a
relationship between persons.
Between persons 'Person' includes companies. There must be at least two partners.
Carrying on a business ` Business includes 'every trade, occupation or profession'
` It can be a single transaction (often referred to as a 'joint venture')
` The business must involve some activity, so if two or more persons are
merely the passive joint owners of revenue-producing property, such as
investments or rented houses, that fact of itself does not make them
partners.
` A partnership begins when the partners agree to conduct their business
activity together which may well be before the business actually begins to
trade. Thus in Khan v Miah 2001 the parties to a proposed venture (running
a restaurant) were partners even before the restaurant opened because, on
the facts, they were clearly carrying on the business (by leasing premises,
hiring equipment and opening a bank account).
In common ie as joint proprietors (normally evidenced by the sharing of profits). For
example, where a shop owner employs a shop assistant, they are both concerned
with running a business at a profit but they cannot be said to be partners.
With a view of profit The test is one of intention, so if partners plan to make a profit but actually make
a loss, that does not stop the arrangement being a partnership. However if the
purpose of the common endeavour is actually to gain business experience, for
example, there is no partnership (Davies v Newman 2000).
The word 'firm' is correctly used to denote a partnership. It is not correct to apply it to a registered
company (though newspapers often do so). The word 'company' may form part of the name of a
partnership (for example, 'Smith and Company') but the words 'limited company' and 'registered company'
can only be applied to a registered company.
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True False
A In England and Wales, an unlimited partnership has no existence
distinct from the partners
B Partners share equally in the venture's profits
In addition, partnerships are governed by the Partnership Act 1890, which sets out basic rights and duties of
partners, such as the rights to share profits, to take part in business decisions and to veto new partners and
the duty to share losses and indemnify other partners. These rights and duties in most cases can be
expressly overruled in a partnership agreement but will be assumed in the absence of any express
provision. The key provisions of the Act are set out below.
Profits and losses These are shared equally in the absence of contrary agreement. If the
partnership agreement states that profits are to be shared in certain
proportions but is silent as to losses, then losses are to be shared in the
same proportions.
Management Every partner is entitled to take part in managing the firm's business; ordinary
management decisions can be made by a majority of partners.
Change in business Any decision on changing the nature of the partnership's business must be
unanimous.
Indemnity The firm must indemnify any partner against liabilities incurred in the ordinary
and proper conduct of the partnership business or in doing anything necessarily
done for the preservation of the partnership property or business.
Remuneration No partner is entitled to remuneration for acting in the partnership business.
Variation The partnership agreement may be varied with the consent of all the
partners.
Records and accounts These must be kept at the main place of business, and must be open to
inspection by all partners.
Interest on capital None is paid on capital except by agreement. However, a partner is entitled
to 5% interest on advances beyond his original capital.
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New partners New partners must only be introduced with the unanimous consent of
existing partners.
Expulsion A partner may only be expelled by a majority of votes when the partnership
agreement allows; even then, the power must only be used in good faith and
for good reason.
Dissolution The authority of the partners after dissolution continues so far as is
necessary to wind up the partnership affairs and complete transactions
already begun. On dissolution, any partner can insist on realisation of the
firm's assets, payment of the firm's debts and distribution of the surplus.
Capital deficiency The remaining partners share a capital deficiency (what a partner owes but
cannot pay back) not as a loss but in ratio to the amounts of capital which they
originally contributed to the firm.
In addition to the rights and duties set out in the Partnership Act, partners also owe fiduciary duties to the
partnership by reason of being fiduciaries (rather like directors owe fiduciary duties to the company). These
duties arise out of general principles of equity. For example, it is a breach of the duty to act in good faith, to
exercise a legal right (eg to expel a partner) for an improper motive. The fiduciary nature of their
relationship also prohibits partners from keeping profits derived from the partnership without the consent
of the other partners and requires them to avoid conflicts of interest without full disclosure. Breach of
these fiduciary duties may render the partner responsible liable to account to the partnership for any
monies received or to make good any other loss suffered.
True False
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The Act specifically provides that where a partner pledges the credit of the firm for a purpose which has no
apparent connection with the firm's ordinary business, the firm will not be bound unless he has actual
express authority to do so.
If any restriction is placed on a partner's authority to bind the firm, no act done in contravention of that
restriction is binding on the firm where the third party has notice of the restriction.
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Note that (except where a partner has actual authority) his authority often depends on the perception
of the third party. Generally speaking, if the third party genuinely believes that the partner has authority,
it is highly likely that the partner will bind the firm.
Note that a new partner admitted to an existing firm is liable for debts incurred only after he becomes a
partner. He is not liable for debts incurred before he was a partner unless he agrees otherwise.
Where a partner retires, he remains liable for any outstanding debts incurred while he was a partner,
unless the creditor has agreed to release him from liability. He is also liable for debts of the firm incurred
after his retirement if the creditor knew him to be a partner (before retirement) and has not had notice of
his retirement. Therefore, it is vital on retirement that a partner gives notice to all the creditors of the
firm. He may also consider entering into an agreement with the continuing partners that they will indemnify
him against any liability for post-retirement debts.
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The principal differences between a registered company and an ordinary partnership are given in the tables
below, the first noting the differences which are commonly seen as advantages of incorporating a business,
the second noting those commonly seen as disadvantages, or conversely, advantages of running a business
as a partnership.
Legal entity Separate legal entity distinct from its Has no independent existence
members
Liability Company liable on its contracts Partners (personally) are jointly and
severally liable on partnership contracts
Limit on liability Members' liability can be limited by shares Partners' liability unlimited
or guarantee
Ownership Company owns assets and ownership not Partners own assets jointly
affected by change of members
Finance In addition to fixed charges, a company An ordinary partnership cannot do so
can raise finance by creating a floating
charge over its undertaking or assets,
allowing it to deal with them without the
lender’s consent prior to any
crystallisation
Change of Company has perpetual succession (ie it is The death, retirement or bankruptcy of
membership unaffected by a change in its members) a partner dissolves the partnership
(subject to the terms of any partnership
agreement)
Transferability Members' shares freely transferable A partner may assign his interest but the
of ownership (subject to articles) assignee does not become a partner as a
result
Limit on No maximum, minimum one Maximum 20 although a greater number
membership is usually permitted in professional
businesses (subject to conditions on the
number professionally qualified and
being members of recognised
professional bodies such as the ICAEW).
Minimum two
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True False
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The limited liability partnership was introduced by the Limited Liability Partnerships Act 2000.
Essentially an LLP is an incorporated partnership that has a legal personality separate from that of its
members (whose liability is limited) and which is subject to less regulation than a registered company. An
LLP is not liable to tax in the same way as a company, however the partners ('members') are taxed as
individuals on partnership profits, just as in an ordinary partnership. It is often an attractive way forward for
firms of professionals because it preserves the partnership ethos in the context of limited liability.
An LLP should not be confused with a limited partnership registered under the Limited Partnership Act
1907. Such partnerships are extremely rare and they are only mentioned here to avoid potential confusion
with LLPs. Briefly, a limited partnership requires at least one general partner who has control of the
management of the business and whose liability must be unlimited. The other partners are not entitled to
participate in management and cannot bind the partnership and their liability is limited to the amount of
capital they invested in the business.
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There is no limit on the number of members in an LLP. New members (apart from the original subscribers)
are admitted by agreement of the existing members. A person ceases to be a member by giving reasonable
notice to the other members or by following any other agreed procedure. Changes in membership do not
affect the existence of the LLP but must be notified to the Registrar within 14 days.
Subject to any partnership agreement, every member may take part in the management of the LLP,
essentially taking on the duties and responsibilities of directors. The obligations to keep and retain
accounting records, to prepare and publish annual accounts (and to have them audited) apply to an LLP as
they do to a company. Similarly, special rules for small- and medium-sized LLPs and audit exemption rules
apply as they do to companies. There is no requirement to provide the equivalent of a directors' report.
Note that an LLP is required to comply with the following.
` To maintain a register of debenture holders and register charges with the Registrar
` To notify the Registrar of any change to membership, designated members or registered office
` To provide the name of the LLP on correspondence and outside its place of business
` To deliver an annual return to the Registrar
As in the case of companies, the members of an LLP may apply to the court in cases of unfair prejudice,
although this right can be excluded with unanimous consent for an agreed period.
True False
B There must be at least one general partner who has unlimited liability
and control of the management of the LLP
C An LLP is normally subject to a requirement to have its accounts
audited annually just like a company
D The members of an LLP are required to prepare a report along the
same lines as a directors' report
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Yes No
B The name and address of at least one designated member must be given
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Summary
All partners agents Formal partnership agreement
of partnership and
Ordinary Fiduciary
Partnership Act 1890
Partnership duties
co-partners Informal
Company Partnership
Yes Entity No
Company Partners
Liability
Limited Unlimited
Company owns Partners own
Assets
Floating charge No
>1 2-(20)
Administrative burden No
Formality
Cost No
Publicity Privacy
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Self-test
Answer the following questions.
1 What is the statutory definition of 'partnership'?
2 A partnership can exist when parties enter into a single transaction rather than a series of
transactions.
True
False
3 Name five rights of partners.
` ………………………………………..
` ………………………………………..
` ………………………………………..
` ………………………………………..
` ………………………………………..
4 Complete the following definition.
Partnership ………………………………... is assets beneficially ……….……………………………….
by the partners (the firm). It does not have to be in ……………………………………shares.
5 Which of the following completes a correct sentence?
A partner is an agent of the firm and therefore binds the partnership by his acts in the partnership
business
A Provided he has actual authority
B Provided the third party knows he is a partner
C Provided the third party doesn't know that he has no actual authority
D Provided the third party doesn't know that he lacks actual authority and knows or believes him
to be a partner
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6 Name five differences between companies and ordinary partnerships which make incorporation
advantageous.
` ………………………………………..
` ………………………………………..
` ………………………………………..
` ………………………………………..
` ………………………………………..
7 Name five differences between companies and ordinary partnerships which make partnership
advantageous.
` ………………………………………..
` ………………………………………..
` ………………………………………..
` ………………………………………..
` ………………………………………..
8 An LLP has a separate legal personality.
True
False
9 Which of the following must be included on the incorporation form?
A Name of LLP
B Location of registered office
C Addresses of all branches
D Names of all members of the LLP
E Tax status of each member of the LLP
F Names of designated members
10 Members of LLPs are agents of the LLP and of each other.
True
False
11 Which of the following must an LLP deliver to the Registrar annually?
A Incorporation documents
B Audited accounts
C Annual return
D Tax returns
12 Can the members of an LLP propose a voluntary arrangement?
Yes
No
Now, go back to the Learning Objectives in the Introduction. If you are satisfied you have achieved these
objectives, please tick them off.
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Answers to Self-test
1 Partnership is the relation which subsists between persons carrying on a business in common with a
view of profit.
2 True
3 ` To be involved in decision-making
` To share in profits
` To examine accounts
` To insist on openness and honesty
` To veto new partners
` To be indemnified by fellow partners
4 Property
Owned
Equal
5 D
6 ` Separate entity
` Liability can be limited
` Company owns property and is liable on contracts
` Company can create floating charge
` Company has perpetual succession
` No maximum on membership
7 ` No formality required on creation
` Partnership need not register accounts and other documents
` Partnership has greater freedom and privacy and less cost through not having to comply with
requirements of companies legislation
` All partners can participate in management
` Withdrawal of capital is generally easier
8 True
9 A, B, D, F
10 False. Members of an LLP are agents of the LLP but not of each other.
11 B and C
12 Yes
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