What are the potential ramifications of not having a Partnership Agreement?

A partnership is a relationship which subsists between persons carrying on business in common with a view to profit.

Farmers who farm in partnership with others will usually automatically form a partnership under the legislation. There are no registration requirements in respect of partnerships, so family members or friends involved in farming operations may unwittingly create a farming partnership. In most cases, a farm will be managed by various partnerships over the course of a farmer’s lifetime (whether the farmer is aware of this or not).

Whether created intentionally or not, a partnership will create legal rights and obligations among the partners. Therefore, it is important to formalise this relationship in a partnership agreement. It is especially prudent as now antiquated legislation can prove ineffective in governing a modern farming relationship.

Why should I consider a partnership agreement?

1: Capital

Default position:  

The partners cannot be compelled to contribute further capital to the partnership, even where the original capital has been exhausted. Also, partners are not entitled to interest on their partnership capital.

Partnership agreement:  

Partners may be required to provide additional capital, and this could be required with less than unanimous approval. The agreement can set out the minimum amount of capital to be provided by any incoming partner, as well as notional interest to be paid on partners’ capital accounts, particularly if capital contributions are unequal.

Capital contributions can be a particularly salient point for farmers since profits are often modest, but there can be a lot of value in the partnership assets.

2: Profits and losses

Default position:  

All partners share equally in profits and losses.

Partnership agreement:

The agreement can contain a detailed provision setting out how profits and losses are to be divided. For example, if two brothers run a farm in partnership but one brother assumes responsibility for most of the day-to-day farm management, they might agree that he be entitled to a greater proportion of the profits.

A key concern for many farmers is how to protect the farm’s assets in the event of a marriage breakdown. A partnership agreement can again help in this scenario. If the agreement makes clear that the partner in question only has a share in the profit and loss, the working capital and land capital will not form part of the ‘matrimonial pot’. Obviously, if a share in the working capital and/or land has been given to that partner, then that is something which the Court would have to consider in terms of financial relief on divorce.

3: Property

Default position:

Partnership property is property originally brought into the partnership stock or acquired on account of the partnership, and must be held and applied by the partners exclusively for the purposes of the partnership. Partnership property is also moveable and so potentially subject to a disruptive legal rights claim on the death of a partner.

Partnership agreement:

It is preferable to set out in the partnership agreement if there are specific assets, such as the farm, tractors or livestock, that are partnership property. Where the partnership uses an asset that belongs to one of the partners, it is advisable to make clear in the agreement that such asset is not partnership property, and the terms on which the partnership is permitted to make use of the asset. It is also possible to state that partnership property is heritable, thus moving it out of the scope of a potential legal rights claim. In addition, the potential issue of uplift in value should be considered.

4: Management and voting

Default position:

All partners can take part in the management of the partnership business and any differences as to ordinary matters connected with the partnership business may be decided by majority vote. However, a change in the nature of the business requires unanimous consent.

Partnership agreement:

The agreement can set out bespoke provisions for management and voting arrangements. For example, a wife who has an interest in the farming partnership but is not entitled to participate in the management of the farm.

5: Duties and responsibilities

Default position:

The duty of good faith of partners to each other is part of the general law.

Partnership agreement:

The duty of good faith is often set out in the partnership agreement by way of reinforcement, and the agreement may also state whether partners are required to devote the whole of their time and attention to partnership business and include an undertaking by partners to promote the interests of the partnership and comply with any decisions made in accordance with the partnership agreement.

Farming partners can allocate duties and responsibilities with bespoke provisions and, given that farmers will often engage third parties on the farm (share farming, contract farming, farm business tenancies, licences to occupy etc.), it can be useful to specify that these third parties are not partners, notwithstanding that they have some of the same/similar duties and responsibilities.

6: Succession

Partnership agreement:

The agreement can include provisions for financial and tax planning, particularly in respect of Business Property Relief (BPR). Having written confirmation that a farm belongs to the partnership can help to support the eligibility for 100% BPR, as opposed to 50% BPR if it belongs to a partner outside of the partnership.

BPR allows business owners to pass on certain business assets at a reduced or 0% rate of Inheritance Tax, subject to certain conditions being met including the assets used in a predominantly trading business.

7: Disputes

Partnership agreement

An agreement removes ambiguity from the managerial process by providing partners with a solid legal basis for decision-making, based on what everyone agrees. Farming partnerships are often inter-familial, so partners will feel that disputes are likely to be resolved amicably among the family members/partners. However, disagreements can be unavoidable.

A partnership agreement can also formalise the dispute resolution process, for example through arbitration or negotiation, in a worst-case scenario to avoid the need to go to court (which would be protracted and expensive).

8: Expulsion

Default position:

No majority of partners can expel a partner unless such a power has been expressly agreed by the partners. Likewise, unanimous agreement is required to admit a new partner.

Partnership agreement:

Through an agreement, the right can be reserved, with the consent of a specified majority of partners, to expel a partner in the case of bankruptcy, long-term illness, mental illness or serious breach of the partnership agreement. In addition, sometimes provision is made for ‘compulsory retirement’ with the consent of a specified majority of partners. For example, where a father who owns/controls the farm becomes mentally/physically incapacitated, the children may want a simple mechanism by which they can remove him from the partnership.

9: Termination and winding-Up

Default position:

A partnership that is entered into for an undefined time is dissolved by any partner giving notice.

Partnership agreement:

Provisions can be included covering the departure of a single partner, allowing the business of the partnership to be continued by the remaining partners, as well as voting provisions specifying the required percentage majority for the partnership to be dissolved and wound up. For example, if a father and his two sons run a farm in partnership, the partnership agreement can provide a mechanism by which the father can retire. Otherwise, when he leaves the partnership is terminated (and should technically be wound-up and a settlement of accounts taken), and a new partnership will be formed between the two sons.

Next steps

If you are in a farming partnership and do not have a partnership agreement in place, you should consider preparing one. If you are in a farming partnership and you have a partnership agreement, you should consider whether it needs to be updated.

Harper Macleod has specialist rural property and partnership lawyers who can prepare or update your partnership agreement.