Leaving a partnership
- John Deane
- Updated: Thu, 12th Jan 2017
When a partner is leaving a general partnership or a limited liability partnership (LLP) for any reason the departure needs to be negotiated. We guide you through the process solving both contentious and non-contentious situations on a practical and legal level.
Our services for departing partners includes:
We act for partnerships involved with a range of professional services such as hedge funds, media agencies, accountancy, law and finance as well as vets, dentists and doctors. Our clients work with us because of our knowledge of the workings of partnerships, the law and the liabilities arising.
Leaving a partnership
The laws relating to partnership do vary depending upon the nature of the partnership. There are three types of partnerships recognised in law:
- Limited liability partnerships – having their own legal identity quite distinct from that of its partners or members;
- Partnerships where the liability of partners is not of limited liability but there is a written partnership agreement – governed by the Partnership Act unless the agreement provides otherwise; and
- Partnerships which are not committed to writing – there is no separate legal identity between the partnership and the partners in law and the partnership will be governed by the Partnership Act.
Why the distinction is important
The status and the liabilities for the partners are not the same under each type of partnership. This means that the issues, pitfalls and approach for commercial negotiations differ.
Leaving a partnership or LLP agreements
Common to any type of partnership is the need for an agreement documenting the rights and liabilities on leaving. An agreement clarifies the position for existing partners and also for the leaving partner and in that respect is of equal benefit.
We have set out below some of the commonly found problems we solve by way of an agreement documenting the terms of leaving, namely:
- Agreeing the restrictions on the outgoing partner;
- Settling liabilities arising after leaving the partnership;
- Sharing income and gains on leaving the partnership.
Restrictions on the outgoing partner
There may be requirements set out in the partnership agreement. However, often the terms are outdated and not effective in protecting the interests of the remaining partners. Sometimes, the partners want to agree that the departing partner can take clients with him but that is in contravention of the existing partnership agreement.
An agreement documenting the specific covenants to apply allows the partners to re-write or create aspects of the partnership agreement fitting with the modern trading landscape.
We do re-write the restrictions attaching to matters which the business needs to protect such as:
- Non-solicitation of clients;
- Non-poaching of staff;
- Restriction from joining a competing business;
- Taking assets owned by the partnership such as intellectual property. Intellectual property would include the data base. Know how in the partner’s knowledge base cannot be restricted ; and
- Confidential information. The common law protections which exist if there is no written agreement are frequently inadequate.
- Protecting the goodwill and brand. Curbing what the departing partner says about the partnership to its clients and competitors is something most partnerships want to closely manage. Management is in practical terms impossible without an agreement between the partnership and the partner who is leaving.
If there is an agreement setting out the restrictions on the partner who is leaving the restrictions will be much easier to enforce. The length of the restrictions is an area often negotiated. However, it is accepted by the courts that much longer restrictions can be placed on partners than say less senior employees.
Benefits to the partnership
If the partnership does discover that the ex-partner is competing against the partnership matters such as obtaining an injunction to stop the competition and then recover damages will be less complicated. The ex-partner will be aware of his obligations and we find less likely to embark on activities which could harm the partnership.
Liabilities arising after leaving the partnership
Former partners can be liable for claims arising on commercial agreements entered into whilst in partnership. Typical problem areas are dilapidation claims on leasehold property and claims under personal guarantees given whilst a partner. There are plenty of cases where former partners have been held to account. The issues apply equally to partnerships as they do to LLPs.
Solutions for partners
Where we are acting for an individual partner who is leaving a partnership we do review the situation and flag up potential future liabilities so that the partner is empowered to negotiate. In some cases it is not possible for the partner leaving the partnership to assign his personal liabilities because, say, the documentation prevents assignment. In those cases we suggest the partner seeks indemnities from the remaining partners.
The partner who is leaving does need to review the professional insurance policy and notify insurers of his date of departure.
Sharing income and gains on leaving the partnership
This is an area where, unless the position is well documented in the partnership agreement, the default position under common law differs for partnerships and LLPs.
Default position for LLPs
The legislation provides little assistance and help for LLP members who wish to depart from an LLP which does not have an agreement setting how income and capital sharing on leaving the partnership.
Solutions for members of LLPs
- Any partner wishing to leave an LLP should ensure that an LLP agreement is drafted as soon as possible, including provisions on leaving. But, if the situation is inflamed, that may not be practical.
- If there is someone who is willing to buy the departing member’s share than a members’ interest purchase agreement can be drafted. But, this will require the consent of all members of the LLP.
- A member can resign from the LLP by giving notice in accordance with the legislation without taking any assets. But, this is not normally satisfactory for the departing member unless the business is not financially viable anymore.
- If there are only two members, the LLP is only allowed to drop to one designated member for up to 6 months before it is wound up by the Court or the official receiver and the remaining member will be personally liable for any LLP debts. If the partners wish to continue the threat of winding up can be a trigger which makes them negotiate an agreement for the partner leaving the LLP.
With LLPs, death does not automatically trigger a dissolution. However, if the LLP agreement does not provide for events upon death, the member’s interest can pass to the estate who will continue to enjoy income and gains. The default provisions are not explicit and claims can arise which are unexpected.
Default positions for partnerships
Subject to anything that is agreed in a partnership agreement, every partnership is dissolved when another partner leaves or dies. However, his or her estate will continue to be subject to income and gains arising up to the point of dissolution under the Partnership Act.
There are threats and claims that partners will consider when there is a fall out and relationships have broken down. The best advice in all cases is to try and reach an agreement as the consequences are potentially drastic. Again, the tactics to consider do differ between partnerships and LLPs.
Contentious fall outs in LLPs
The possibilities include depending upon the facts:
Member’s Voluntary Liquidation
The members can start a Members Voluntary Liquidation process. In order to do this, the LLP must meet a range of requirements which includes a statement of solvency for the LLP that it is able to pay its debts over the next 12 months. The administrative requirements to formally liquidate the company which includes appointing a liquidator who will value and divide the remaining assets may prove too costly for seeking this avenue. In addition, the option is only available if all the members agree to bring the LLP to an end.
Court petition and winding up
The members can present a petition to the court to wind up the LLP as an entity. A sole remaining member may also present the petition. The down side to this option is that the compulsory liquidation process will see a court appointed liquidator take control of all the assets of the LLP and the member will be unable to interfere with the process.
Striking LLP off the Companies House Register
Members can apply to strike the LLP off the Companies Register. However, all remaining assets will pass to the crown under the bona vacantia rule. It would be advisable that the LLP members hire an accountant to value the LLP to ensure the assets are apportioned fairly between the LLP members. The remaining assets must then be extracted from the LLP before any strike-off application is made. This option will also require co-operation of the LLP and the members shared desire to bring the LLP to an end.
Unfair prejudice or just and equitable wining up claims
A member wishing to depart from an LLP where the situation has become unresolvable should consider this option. The departing member should at this point review whether any understanding has ever been agreed that an outgoing members would receive a certain share of the LLP, even if no agreement has been reached. This option is however cost-heavy, unpredictable and lengthy, so the parties should try and reach an agreement if possible.
Forced departures from the partnership or LLP
For both partnerships and LLPs, there is no power to expel any partner unless it is included in the partnership agreement. If, as we often find, there are no provisions for expelling partners the partnership will have to come to an agreement with the partner they force out if they wish to continue the business.
The partners do need to consider the attacks they may face on expelling a partner without either good grounds and/or not in accordance with the partnership agreement. Many of the cases we deal with are where the agreement is ambiguous in terms of any or all of:
- What are sufficient reasons to expel;
- What process should be followed;
- Is notice required or can expulsion be immediate;
- Whether there are enforceable restrictions on the partner if he is expelled or forced out.
Unfair dismissal: In some cases, usually a more junior partner, may claim that his status and standing within the partnership is akin to that of an employee. The reason for such a claim would be to bring a claim for unfair dismissal in the Employment Tribunal.
Breach of contract: If the partnership agreement is not explicit, and if the terms set out in the partnership agreement have not been followed, there is the risk that the partner forced out brings a claim for breach of the agreement. The same rules apply to partnerships as apply to any other form of commercial agreement.
If faced with a breach of contract claim the issues to be tuned into include:
- Strength of the evidence – both partners and partnerships need to consider the evidence;
- Standards expected of the particular partner and responsibilities – this will depend upon the reason for expulsion;
- Has the former partner mitigated his loss – the partner does have a duty to look for a new job;
- Have there been attempts to mitigate against the cost of litigation – this duty applies equally to partners and partnerships;
- How much is the likely damages claim worth?.
We are experienced in advising on partnership legal issues. It is always advisable to avoid a dispute and seek a commercial alternative. The terms of leaving and continuing obligations on the partner do need to be set out in a written agreement.
It can be tricky when you're leaving an LLP. It is a specialist area of law. Our years of experience gained from both sides of the fence will resolve your problems. Why not call or email me to arrange an informal discussion...