We are asked to prepare partnership agreements for farming businesses on a regular basis. Some of these businesses have operated without a written partnership agreement for a number of years – if not decades – before a decision is made to “bite the bullet” and record the agreement of the partners in writing. So what triggers the desire for a written partnership agreement, and why do some businesses delay?
Reasons to have a written partnership agreement
If you are “carrying on a business in common with a view of profit” with one or more other people, the Partnership Act 1890 automatically applies to your partnership. Some of the provisions of the Partnership Act 1890 are not appropriate to many partnerships, including those in the agriculture sector in the 21st century.
However the reasons for instructing a solicitor to prepare a partnership agreement emanate from more practical considerations than the realisation that esoteric provisions of a 129-year old piece of legislation might not fit your own circumstances.
The result of advice from your accountant – tax mitigation
Recently more accountants are advising their clients to ensure that the real estate assets of the partners appear on the balance sheet of the partnership. There are often sound reasons for this: assets which form part of the capital of the partnership (and therefore on the balance sheet of the partnership) are more likely to benefit from Business Property Relief (“BPR”) in full.
Where real estate assets appear on the balance sheet of the partnership, the default position under the 1890 Act is that all Partners automatically share equally in the profits and losses of the Partnership. Often in many farming partnerships the real estate capital is owned unequally between the Partners (perhaps the mother and father will hold all the real estate capital, with a son or daughter not holding any share in the property) and so it is often decided that it is more appropriate for all capital profits and losses arising from that land to be shared between the land-owning partners (the mother and father in our example), than amongst all the Partners in equal shares.
Consequently it is common for us to be instructed to provide that the capital profits arising from land are shared in proportion to the pattern of land ownership.
Succession Planning - admitting a new partner
Farming is often both a physically demanded occupation and a family affair. As people grow older it is natural to wish to be less involved in the day-to-day activities on the farm, and pass on the business to the younger generation.
Having a written partnership agreement which records the admission of the younger partner can stimulate a sense of ownership in the partnership - even if (or perhaps especially if) the share in capital profits of the partnership upon admission are relatively modest. Entering into a partnership agreement can shift the mentality from a “hired hand” to “business owner” that might be lacking if the formality of signing an agreement were lacking.
As partnership agreements set out the relationship between the partners, the written partnership agreement can set out those things which were taken for granted when the husband and wife were the only partners - perhaps relating to holiday entitlement, how decisions are made and time to be dedicated to the business. Perhaps when a new partner has been admitted to the partnership it is especially important to take the opportunity to specifically address how the expectations have changed from the status of “employee” to “partner”.
Reasons why people delay having a written partnership agreement
It is difficult to give definitive reasons as to why partnerships delay in formalising the partnership in written form, although we suspect that a significant number of partnerships refrain from doing so simply because the issue has not been raised – as we noted above, it is quite possible for a partnership to exist without a written partnership agreement being in place, and for many the provisions of the Partnership Act 1890 are perfectly sufficient.
In fact, there are many perfectly valid reasons why partnerships delay in formalising the partnership.
It is important, however, that the partners have decided that a written partnership agreement is not necessary on the basis of professional advice – either from their accountant or trusted legal advisor. Without having taken that advice, there is a risk that the legal or accounting position is not quite how the partners intend it: often when these issues raise their head it is too late to take appropriate action, and the partners find themselves in the realm of damage limitation, not to mention the potential of damaged family relationships and a business in financial difficulties.