Business partnerships - the law dictates the terms unless partners agree otherwise

20 February 2020

There is one very good reason (among many others) why it’s important to clearly document any business arrangement. That’s because, in certain circumstances, the law will impose the terms of the arrangement on the parties if they do not record the terms of their arrangement themselves. One such instance is where the law determines there is a partnership.

Business founded on friendship succeeds but friendship fails

In a recent case one of the partners was looking for a development opportunity and his friend (a real estate agent) found a property for him to purchase. After the property had been purchased, the friends agreed to subdivide it into three lots, relocate the existing house which was the agent’s property, build two additional houses on the land, and sell the three sections for a profit. The agent agreed to manage the development on a day to day basis. The friends’ relationship turned sour during the development. On completion of the development the partner who owned the properties refused to pay the agent any of the funds from the sales. The friends argued about whether the agent was entitled to be paid for the re-located house and how the profits were to be shared. The Court found the development project was legally a partnership and therefore the profits were to be shared equally, despite the partners’ different understandings about their contributions to the development and how the profits were to be shared.

Partnership law

The terms of a partnership are currently governed by the Partnership Act 1908. The 1908 Act will be replaced by the Partnership Law Act 2019 which will come into force on 21 April 2020. The 2019 Act re-enacts and modernises the 1908 Act but doesn’t substantially change the law.

If the law does determine a partnership exists, then the default terms will be those set out in the applicable Act. A partnership exists where persons (or other legal entities) are carrying on a business in common with a view to profit. There are no formal requirements for the creation of a partnership – the partnership may be formally documented or it may be an oral arrangement. Whether or not a partnership exists will be a legal question to be determined by the Court, and not necessarily what the parties themselves call their arrangement.

A partnership is “fiduciary” in nature. This means the partners must act in good faith and honestly with each other, they must provide full accounts of all information and assets in their possession or control, they must avoid conflicts of interest and avoid profiting personally from the partnership opportunities and information. When the partnership dissolves, each partner is entitled to have the partnership property applied to the debts of the partnership, to have their capital contributions repaid and to have the remaining surplus shared equally among them (even if they contribute unequally by way of capital or effort). The partners can vary these default terms by agreement and minimise disputes - preferably by recording their agreement in a professionally prepared document.

Barbara McDermott is part of our Corporate & Commercial team at Norris Ward McKinnon.