Partnerships

Unlike a company, a partnership does not constitute a separate legal entity.  This means that unlike the shareholders of a company, who have some protection from a company’s debts and legal obligations, each individual partner is liable for the actions and debts created in the name of the partnership, and the individual assets of each partner may be at risk if the partnership fails to pay its debts.

Any two or more individuals, companies or trusts can enter into a partnership arrangement in Australia, as long as the partner entity has the legal capacity to do so (for example, it is not insolvent or under eighteen years of age (in the case of a natural person)).

One potential disadvantage of a partnership is that generally, partnerships are limited to a maximum of twenty partners, unless the partnership is formed to carry on a prescribed profession.  Below are examples of the exceptions to the twenty partners limit:

(a)   Accountants: 1000;

(b)   Lawyers: 400;

(c)   Architects: 100;

(d)   Medical practitioners: 50;

(e)   Share and stockbrokers: 50.

In Australia, there are no specific legal requirements to form a partnership, except that the partnership must:

(a)   be established by two or more persons (subject to size limitation and legal capacity, discussed below);

(b)   carry on a business in common with the other partners;

(c)   be intended by the partners to actually be a partnership (either through express or implied conduct);

(d)   operate with the goal of making a profit;

(e)   have its own tax file number;

(f)   have its own Australian business number (and use it for all business dealings); and

(g)   register for GST (if the collective partnership turnover is $75,000 or more).

Although it is possible for partnerships to be formed without a formal written agreement between the partners, this can lead to a range of unintended consequences, such as disproportionate taxation obligations for individual partners, an inability to have input into the management of the partnership by an individual partner, or an inability for the partnership to continue on without dissolving when a partner retires or dies.  For this reason, it is strongly recommended that a formal, written partnership agreement is entered into when establishing a partnership.

A partnership agreement is a contract that creates an agreement between the partners, regulating the way the partnership operates, how profits will be divided, who has the responsibility for managing the partnership, how conflicts and disputes are to be resolved, how new partners can join the partnership, and how existing partners can leave the partnership.  It also prevents the partnership from dissolving if a partner leaves the partnership or dies.

If a partnership agreement is not entered into, depending on the state or territory your partnership operates in, there may be legislation that provides a default position in relation to the matters referred to above.  In Victoria, for example, the Partnership Act 1958 (Vic) sets out that in the absence of a partnership agreement:

(a)   all profits (or losses) must be shared equally between partners;

(b)   the partnership must indemnify each partner for expenses incurred in conducting the business;

(c)   every partner must take part in the management of the business;

(d)   no partner is entitled to remuneration for acting in the partnership;

(e)   no new partners can enter the partnership without the consent of all existing partners;

(f)   any disputes between partners must be resolved by the majority of partners; and

(g)   no changes to the nature of the partnership can be made without the consent of all existing partners.

This is a non-exhaustive list, and depending on your state or territory, there can be a number of unintended consequences in the absence of a tailored partnership agreement to displace the default legislative rules.

As noted above, a partner will be personally liable for the actions and debts created in the name of the partnership.  However, through the partnership agreement the partners will allocate liability between themselves through cross-indemnities – this means even though a third party may pursue one partner for 100% of a liability incurred by a partnership, each partner will indemnify each other partner against any liability of the partnership so that the each partner’s liability will be limited in proportion with its interest in the partnership.

The partnership agreement will also address profits generated by the partnership, providing that each partner will be entitled to those profits in proportion to its interest in the partnership.

A change to the composition of a partnership is inevitable.

From time to time, partners will retire, a partner may leave the partnership to pursue other opportunities, a partner may wish to transfer its partnership interest to a third party, or the partnership may seek a new party to be admitted as a partner.

Generally, any change in the composition of a partnership will result in the dissolution of the original partnership and the creation of a new partnership.  The dissolution of a partnership has a number of legal implications (for example, the winding up of the partnership) and tax implications (for example, the requirement to apply for a new tax file number and ABN, and to lodge separate tax return for the newly formed partnership).

In limited circumstances, the change to the partnership’s constitution will be treated as a reconstitution of the partnership, and will not result in the winding up of the partnership.  For a reconstitution to occur, the following conditions must be satisfied:

(a)   the partnership agreement allows for a change in the membership;

(b)   at least one of the existing partners remains a partner after the change;

(c)   the partnership agreement provides that the change does not give rise to a dissolution of the partnership;

(d)   there is no break in the continuity of the enterprise conduct by the partnership; and

(e)   there are no changes to, amongst other things, the nature of the business, the customer base, or the business name of the partnership.

The partners may agree on a specific procedure for the winding up of the partnership, and detail such procedure in the partnership agreement.  In the absence of agreement on the winding up procedure, or of a partnership agreement, the partnership may be wound up in accordance with the provisions of the governing legislation.