Farming partnership agreements: back to basics

The farming sector is dominated by family-based businesses, and for historical, tax and practical reasons the overwhelming majority of these family businesses trade through partnerships. 

Many partnerships in the agricultural sector do not have a written agreement, also known as a 'partnership agreement', that sets out how the partnership is to be run, and the legal relationships between the partners, relying on familial relationships to ensure that the 'right' outcome is reached. Over time family dynamics, relationships and expectations can evolve and so it's essential that the partners understand the legal framework that sits behind their involvement in the family business. 

In this article we examine: 

• The position between the partners where there is no written partnership agreement in place - what we refer to as the 'default position'.
• The reasons why family farming partnerships should consider deviating from the default position. 

Written partnership agreements can often be a useful tool in the context of tax planning. Formerly the focus tended to focus on mitigating income tax liabilities, but with the imminent implementation of reforms to Business Property Relief and Agricultural Property Relief, written partnership agreements have become an important means by which inheritance tax liabilities can be mitigated. We explore this topic in more detail in our forthcoming companion article, 'Partnership agreements: taxation'.

Decisions and management

The default position is that decisions of a partnership are to be reached by a majority of members, with the only exception being that the partners must act with unanimity in order to change the nature of the business. Notably, an unruly or disruptive partner cannot be expelled by the other partners.

The default situation may not be appropriate where:

• There is an even number of partners, which increases the possibility of a 50:50 split and therefore deadlock.
• The farming land is on the balance sheet of the partnership, and the landowning partner(s) wish to control the timing, price and arrangements for the sale of the land owned by them.
• There is a disparity between the experience and knowledge of the partners.  

Partnership agreements will often set out:

• How decisions are made (day-to-day and strategic).
• Each partner’s voting rights.
• Which partner (if any) will have a casting vote or veto powers.
• The decisions where unanimous agreement is required.
• How and when partners’ meetings will take place.
• The circumstances under which a partner can be expelled from the partnership.

Division of trading profits and losses

In the absence of a written agreement, the default position is that profits and losses are shared equally, and any deviation from this position will need to be agreed by all the partners. 

Equal division of trading profits and losses might not be appropriate where the partners: 

• Do not contribute equally to the day-to-day running of the partnership business. 
• Have contributed different levels of capital/assets to the business.
• Have other sources of income - which may have an impact on income taxes.
• Have differing abilities to absorb the financial shock of a loss-making year.   

Whilst the partners may agree year-to-year on an unequal allocation of trading profits, it can often be useful to set out what will happen where the partners do not agree, which is more likely for any year where there is a trading loss. Accordingly a written partnership agreement can set out clearly: 
 
•    How profits and losses are to be shared;
•    Whether any partner is entitled to a priority return (akin to a salary) before any residual trading profit is shared between the partners; and
•    How and when drawings can be taken. 

Division of capital profits

As with trading profits and losses, the default position is that capital profits and losses are shared equally, and any deviation from this position will need to be agreed by all the partners. 

Equal division of capital profits and losses might not be appropriate where the partners: 

• Have contributed different levels of capital/assets to the business.
• The farming land is on the balance sheet of the partnership and that land is not owned by all the partners, or is owned in unequal shares.
• Wish to mitigate the impact of the impacts of the reforms to Business Property Relief and Agricultural Property Relief - we explore this topic in more detail in our forthcoming companion article, 'Partnership agreements: taxation'.

Differences in the expectations of the partners on sharing capital and capital profits will often only become apparent upon the retirement, expulsion or death of a partner. Because the cash values can be relatively high, especially when the capital profit has arisen from the sale of land, disputes or resentment can often arise when it's too late to reach a considered position that suits the needs of the family as a whole. 

Accordingly the partnership agreement should set out clearly:

• Whether there are different classes of capital - general capital and land capital for example.
• The proportions in which the partners hold each class of capital in the business.
• How capital profits, for example from the sale of land, are divided between the partners.

Succession and exit planning

The default position is that: 

• Any partner may dissolve the partnership at any time.
• The retirement, death and bankruptcy of a partner may trigger dissolution of the partnership. 

Dissolution of the partnership can involve the liquidation, i.e. sale, of all assets of the partnership so that the creditors are repaid and the residue is shared between the partners in equal shares. 

The default position is often unattractive because:

• Any single partner can end the business (and way of life) for the whole family.
• Any single partner’s lack of financial control can dramatically impact on the rest of the family.
• The family will often want to continue the business following the death.
• A partner may want to gift its share in the business to another family member in their will. 

A written partnership agreement for a family farming partnership will often:

• Restrict the ability of a single partner to dissolve the partnership.
• Provide for the continuation of the business following the retirement, expulsion and death of a partner.
• Set out the procedures for retirement and expulsion new partners.
• Set out how a departing partner will receive their value in the business, and the manner in which that share is valued.
• Set out the extent of each partner’s ability to gift their share of the partnership upon their death. 

Final thoughts

A partnership agreement needs to put the partnership in a position where it can achieve its commercial objectives. Additionally, partnership agreements for family farming businesses will need to take account of the personalities and family dynamics of the family members: whether they are currently partners or expected to be partners in the future as part of a succession plan. 

Our team is experienced in guiding farming families on preparing partnership agreements that suits their needs, working hand-in-hand with the partners’ accountants and other professional advisers. 

For further information, please get in touch with Jonathan Croley.