Partnership governance - Common provisions in partnership ag...

Learning Outcomes

This article outlines partnership governance in English law, focusing on how agreements vary default rules under the Partnership Act 1890 and covering capital contributions and profit sharing, decision-making and management, authority to bind the firm, admission, expulsion and retirement, dissolution and continuation provisions, asset ownership and partnership property, indemnity arrangements, and the scope and enforceability of post-termination restrictive covenants in the SQE1 context.

SQE1 Syllabus

For SQE1, you are required to understand how partnership agreements operate in practice and how they can modify the default statutory rules, with a focus on the following syllabus points:

• The default rules of the Partnership Act 1890 and how they may be varied by agreement.
• The main provisions typically included in partnership agreements, such as capital contributions, profit and loss sharing, management, expulsion, dissolution, asset ownership, indemnity, and restrictive covenants.
• The legal and practical consequences of including or omitting certain clauses.
• How to apply partnership agreement provisions to problem scenarios and MCQs.
• Which PA 1890 provisions are effectively mandatory in dealings with third parties (e.g. agency and liability ss.5–18) and which can be varied inter se.
• How profits and losses are shared by default; the no-remuneration rule; interest on advances beyond agreed capital (s.24).
• Decision-making: majority rule for ordinary matters and unanimity for changing the nature of business, admission of partners, and variation of the agreement (ss.19, 24).
• Authority to bind: actual and apparent authority (s.5), limits on internal authority, and indemnity between partners if limits are breached.
• Retirement and expulsion: no expulsion without express clause (s.25); notices of retirement to prior and new counterparties (s.36); holding out (s.14); incoming/outgoing liability (s.17).
• Dissolution and continuation: automatic dissolution events (ss.32–33); order of distribution (s.44); continuation and buy-out provisions; valuation of goodwill and work in progress.
• Partnership property: intention test and consequences; documenting ownership and usage.
• Restrictive covenants: legitimate interests, scope, duration and geographic reasonableness.
• International and tax points: transparent income taxation of partners, VAT registration thresholds, governing law and jurisdiction clauses.

Test Your Knowledge

Attempt these questions before reading this article. If you find some difficult or cannot remember the answers, remember to look more closely at that area during your revision.

1. Which default rule under the Partnership Act 1890 applies if there is no express agreement on profit sharing?
2. Can a partner be expelled from a partnership without an express expulsion clause in the partnership agreement?
3. What is the effect of failing to specify ownership of assets contributed by partners in the partnership agreement?
4. In the absence of agreement, how are decisions made regarding changes to the nature of the partnership business?

Introduction

When two or more people carry on business together, they may form a partnership. The Partnership Act 1890 (PA 1890) provides default rules, but most partnerships will want to tailor their arrangements by entering into a written partnership agreement. Such agreements are essential for clarifying rights and obligations, reducing disputes, and ensuring the partnership operates as intended. They also reduce the risk of operating a “partnership at will”, which may be terminated by any partner on notice, and which dissolves automatically on death or bankruptcy of a partner. This article examines the most common provisions included in partnership agreements and explains their legal effect for SQE1.

Capital Contributions and Profit Sharing

The PA 1890 states that partners share profits and losses equally unless agreed otherwise. However, partners often wish to reflect differences in capital, effort, or skill. Agreements therefore commonly distinguish between capital profits (e.g. on sale of property or goodwill) and income profits (trading profits), and set different ratios for each.

Key Term: capital contribution
The amount of money, property, or other assets each partner invests in the partnership, either at the outset or during its operation.

Key Term: profit sharing ratio
The agreed proportion in which partners share the profits (and usually losses) of the partnership.

A well-drafted agreement typically addresses:

• Initial and further capital, including whether further “capital calls” may be required, and consequences of default.
• Interest on advances: under s.24(3) PA 1890, a partner who makes an advance beyond the agreed capital is entitled to 5% per annum interest unless varied by agreement. Many agreements set a different rate or require partner approval for advances.
• Drawings and salaries: by default no partner is entitled to remuneration for acting in the partnership (s.24(6)), so any fixed “salary” for a partner must be expressly agreed. In practice “salaries” are usually a priority share of profits shown in the appropriation account, not an employee wage.
• Appropriation account: setting out the order in which net profit is allocated (e.g. partner “salaries” first, then interest on capital/advances, then residual profit split by the agreed ratio).
• Loss sharing: absent agreement, losses follow profits. Agreements often state expressly that losses are shared in the same proportions as residual profits.

Worked Example 1.1

Scenario: Three partners form a partnership. Partner A contributes £50,000, Partner B contributes £25,000, and Partner C contributes no capital but will manage the business full-time. There is no express agreement on profit sharing.

Answer:
In the absence of agreement, profits and losses are shared equally under s.24(1) PA 1890. However, this may not reflect the partners' intentions. A partnership agreement could specify a different profit sharing ratio to reward capital or effort.

Worked Example 1.2

Scenario: P and Q agree to run a consultancy. Q expects a fixed monthly “salary” of £4,000 for managing operations. The written partnership agreement is silent on remuneration.

Answer:
Under s.24(6) PA 1890 no partner is entitled to remuneration for acting in the partnership. Q’s “salary” is not payable unless expressly agreed. The partners should amend the agreement to provide for drawings/priority profit allocation if that reflects their intentions.

Decision-Making and Management

By default, all partners may take part in management, and ordinary matters are decided by majority. However, changes to the nature of the business, admission of new partners, or changes to the agreement require unanimity.

Key Term: management clause
A provision in the partnership agreement setting out how decisions are made, who manages the business, and any special roles or voting rights.

Agreements often improve clarity by:

• Defining “ordinary” versus “reserved” matters. Ordinary matters (e.g. routine purchases within budget) may be decided by simple majority; reserved matters (e.g. borrowing, leases, large asset purchases, litigation, guarantees, changes to business lines, opening/closing sites) may require unanimity or an enhanced majority.
• Designating roles (e.g. managing partner, finance partner) and conferring limited authority thresholds (e.g. spending or contracting limits).
• Providing voting mechanics: quorum, notice, chair, casting vote, and minuting decisions.
• Aligning internal authority and external contracting: limits bind partners inter se, but do not affect apparent authority to third parties unless those third parties know of the limits.

Authority to bind the firm is governed by agency principles in s.5 PA 1890. A partner who acts with actual or apparent authority can bind the firm to third parties. An agreement can restrict a partner’s actual authority; if a partner exceeds actual authority, the act may still bind the firm if it falls within the usual course of the firm’s business and the third party does not know of the lack of authority. Internally, the acting partner must then indemnify their co-partners for any loss.

Worked Example 1.3

Scenario: A partnership agreement gives Partner X a casting vote on all management decisions. The partners disagree on a major contract. Partner X uses the casting vote to approve it.

Answer:
The agreement overrides the default rule of equal management. The casting vote provision is valid and the decision stands, provided the clause is clear and all partners agreed to it.

Worked Example 1.4

Scenario: A two-partner design firm’s agreement limits any single contract to £10,000 without both signatures. Partner M signs a £15,000 software subscription with a supplier, a common tool in the industry. The supplier had no notice of the internal limit.

Answer:
The contract likely binds the firm due to M’s apparent authority to procure usual business software (s.5). Internally, M has breached the agreement and must indemnify the other partner for any resulting loss under the indemnity between partners.

Expulsion and Retirement

The PA 1890 does not allow expulsion of a partner unless expressly agreed. Without an expulsion clause, partners cannot remove a problematic partner, even for misconduct.

Key Term: expulsion clause
A provision in the partnership agreement allowing the partnership to remove a partner in specified circumstances and following a set procedure.

Well-drafted expulsion clauses:

• Specify grounds (e.g. serious breach of agreement, dishonesty, gross misconduct, persistent underperformance, loss of professional licence).
• Set out fair procedure (notice of allegations, reasonable opportunity to respond, decision by disinterested partners).
• Exclude the subject partner’s vote from the decision and related quorum counting.
• Deal with consequences: calculation of the outgoing partner’s share (capital, current account, undrawn profits), treatment of goodwill, and time for payment (often with staged payments).
• Address post-termination obligations (return of property, confidentiality, restrictive covenants).

Retirement should also be expressly regulated: notice period, timing (e.g. year-end), and valuation/buy-out terms. Absent an agreed fixed term, any partner may determine a “partnership at will” by notice (s.26), which may disrupt the business.

On retirement or expulsion, liability to third parties divides into:

• Past debts: a retiring partner remains liable for debts incurred while they were a partner (s.17(2)). Novation with creditors can release liability, but is uncommon; instead, continuing partners often give a contractual indemnity to the retiree.
• Future debts: a retiree avoids liability if proper notice is given (s.36). Actual notice must be given to persons who previously dealt with the firm; notice by advertisement in the London Gazette is deemed notice to others. Avoid “holding out” (s.14) by removing the retiree’s name from stationery, website and registers, and discouraging statements implying continued partnership.

Worked Example 1.5

Scenario: Partner D is persistently absent and damaging the firm's reputation. The partnership agreement contains an expulsion clause for serious misconduct, requiring a majority vote and written notice.

Answer:
The partners may expel D by following the procedure in the agreement. If there were no expulsion clause, D could not be removed unless all partners agreed to dissolve the partnership.

Exam Warning

The absence of an express expulsion clause means a partner cannot be expelled, even for serious misconduct. This can force dissolution of the partnership if the other partners cannot work with the problematic partner.

Worked Example 1.6

Scenario: R retires from a three-partner firm. The firm continues under the same name. R emails key clients but does not give written notice to long-standing suppliers. The firm leaves R’s name on old letterhead used occasionally.

Answer:
R remains potentially liable for future contracts with previous counterparties who did not receive actual notice (s.36). Continuing to use stationery naming R, and any statements implying R is still a partner, may amount to “holding out” (s.14), exposing R to liability. Best practice: send actual notices to all who have dealt with the firm and publish a Gazette notice; promptly remove the retiree’s name from all materials.

Dissolution and Continuation

Under the PA 1890, a partnership dissolves on death, bankruptcy, or notice by any partner in a partnership at will. Many agreements include clauses to allow the partnership to continue despite these events.

Key Term: continuation clause
A provision allowing the partnership to carry on after the departure, death, or bankruptcy of a partner, rather than dissolving automatically.

Continuation provisions typically:

• State that the firm continues between the remaining partners upon death, bankruptcy, or retirement of a partner, without winding up.
• Include a buy-out mechanism for the outgoing partner’s share (or the deceased partner’s estate), covering capital, current account, share of undistributed profits, and an agreed approach to goodwill and work in progress (WIP).
• Provide valuation methodology (e.g. multiple of average profits, independent accountant determination, book value for tangible assets, specified rules for WIP/unbilled time).
• Set payment terms (instalments, interest, security) to manage cash flow.
• Confirm use of the firm name and ownership of goodwill, files, and client relationships post-departure.

On winding up, s.44 PA 1890 prescribes the order of application of assets: first to outside creditors, then partners’ advances, then partners’ capital, with any surplus distributed among partners according to their profit-sharing ratios.

Worked Example 1.7

Scenario: A three-partner professional firm has a continuation clause stating that on death of a partner the firm continues and the deceased’s capital and share of goodwill are to be paid over 24 months, with goodwill valued at one year’s average profits.

Answer:
The firm does not dissolve on death. The estate is entitled to the deceased’s capital and the goodwill payment as per the agreed valuation and instalment terms. Clear continuation and valuation provisions avoid a compulsory winding up and provide predictable outcomes.

Capital and Asset Ownership

Disputes often arise over whether assets used in the business are partnership property or belong to individual partners. The agreement should specify ownership and procedures for withdrawal or valuation. The intention of the partners is key. Property bought with partnership money or acquired on account of the firm is presumed to be partnership property, even if legal title is in a partner’s name, whereas property a partner brings in for personal use may remain personal unless agreed otherwise. The classification has important consequences on dissolution and exit.

Key Term: partnership property
Assets owned by the partnership as a whole, used for partnership purposes, and shared among the partners according to the agreement.

Key Term: personal property
Assets owned by an individual partner, not by the partnership, and not subject to division on dissolution.

Good drafting practices include:

• A schedule of partnership property, with periodic updates.
• Clauses dealing expressly with assets introduced by partners (e.g. premises, vehicles, intellectual property) and whether they become partnership property or remain personally owned but licensed to the firm.
• Terms for use of personal assets in the business (licence terms, rent, repair, insurance).
• Clear rules on capital allowances and tax treatment (coordinated with each partner’s tax advisers).
• Exit provisions for valuation and transfer of partnership property or release of licences.

Revision Tip

Always specify in the agreement which assets are partnership property and which remain personal property. This avoids disputes if a partner leaves or the partnership dissolves.

Worked Example 1.8

Scenario: Partner E uses their personally owned van for firm deliveries. The firm pays insurance and maintenance. No clause classifies the van. On E’s retirement, the firm claims the van as partnership property.

Answer:
The intention of the parties governs. Mere use for the business and payment of running costs do not necessarily convert personal property into partnership property. Without an express agreement or evidence that the van was introduced as capital or purchased with partnership funds, it is likely to remain E’s personal property. A clause specifying ownership and any hire/licence terms would have avoided the dispute.

Indemnity and Restrictive Covenants

The PA 1890 provides that the firm must indemnify partners for payments made in the ordinary course of business. Agreements may clarify or expand indemnity provisions and include restrictive covenants to protect the business after a partner leaves.

Key Term: indemnity clause
A provision requiring the partnership to reimburse partners for liabilities incurred on behalf of the firm.

Common indemnity terms address:

• Reimbursement of partners for liabilities properly incurred on firm business (statutory default reflected in s.24(2)).
• Indemnity by continuing partners of an outgoing partner against future liabilities, and cooperation with notices to third parties.
• Allocation of responsibility where a partner exceeds authority: the acting partner indemnifies co-partners for loss caused by breach of internal limits.
• Professional indemnity insurance obligations and notification/cooperation requirements.

Key Term: restrictive covenant
A clause restricting a partner's ability to compete with the partnership or solicit clients after leaving, provided it is reasonable in scope and duration.

Restrictive covenants are enforceable only to the extent reasonably necessary to protect legitimate interests (typically goodwill, confidential information, and stable workforce). Reasonableness is judged by scope of activities restricted, geographic area, and duration. Covenants should be no wider than necessary:

• Non-compete: effective but closely scrutinised; durations of 6–12 months are more likely to be upheld in local service businesses; geographic limits should reflect the firm’s client base.
• Non-solicitation and non-dealing: often easier to justify than blanket non-competes; can be tailored to clients serviced by the departing partner in a specified look-back period.
• Non-poaching of staff: must be limited to staff whose stability is a legitimate interest.

Worked Example 1.9

Scenario: A high-street accountancy partnership includes a clause barring ex-partners from practising accountancy anywhere in the UK for five years.

Answer:
This is likely to be an unreasonable restraint of trade: the geographic scope and duration are broader than necessary to protect goodwill. A narrower clause, e.g. a 12-month non-solicitation/non-dealing restriction limited to clients of the firm (or of the departing partner) and a reasonable local radius, would be more likely to be enforceable.

International and Tax Considerations

Where a partnership operates in more than one jurisdiction, the agreement should specify the governing law and address tax implications for each partner. Ordinary partnerships are fiscally transparent in the UK: the partnership itself is not subject to income or corporation tax; individual partners are assessed on their share of profits and chargeable gains. Agreements can assist partners by:

• Setting accounting dates and accounting policies for profit allocation.
• Addressing partner drawings and tax reserves (e.g. monthly drawings with annual “true-up”).
• Requiring each partner to account for their own tax liabilities and to indemnify the firm for tax attributable to their share.
• Providing VAT governance (e.g. appointment of a responsible partner; compliance procedures). Partnerships making taxable supplies must register for VAT when their taxable turnover exceeds the prevailing registration threshold and charge VAT on supplies accordingly.
• Considering cross-border compliance: permanent establishment risks, registrations, and withholding taxes, with tailored advice.

Key Term: governing law clause
A provision specifying which country's law applies to the partnership agreement and disputes.

Governing law and jurisdiction clauses add certainty, especially for cross-border practices or overseas clients. Dispute resolution clauses (mediation/arbitration) may be appropriate for confidential and efficient resolution of partner disputes.

Worked Example 1.10

Scenario: A boutique consultancy has partners based in England and Scotland and clients across the UK and EU. The partners want consistent dispute resolution rules and clarity about applicable law.

Answer:
Include a governing law clause (e.g. “This agreement and any non-contractual obligations arising out of or in connection with it are governed by the law of England and Wales”) and a jurisdiction or arbitration clause. This reduces uncertainty where operations and clients span multiple jurisdictions.

Key Point Checklist

This article has covered the following key knowledge points:

• The Partnership Act 1890 provides default rules, but most partnerships use written agreements to vary them.
• Common provisions in partnership agreements include capital contributions, profit sharing, management, expulsion, dissolution, asset ownership, indemnity, and restrictive covenants.
• Expulsion of a partner is only possible if expressly provided for in the agreement.
• Asset ownership should be clearly defined to avoid disputes on exit or dissolution.
• Indemnity and restrictive covenants protect the partnership and its partners.
• International partnerships should address governing law and tax issues in the agreement.
• Default rules include: equal sharing of profits and losses; no partner remuneration; majority for ordinary matters, unanimity for changing the business, admitting partners, and varying the agreement.
• Authority to bind the firm arises from actual or apparent authority; internal limits bind partners but not third parties without notice; an acting partner must indemnify co-partners for breaches of internal limits.
• Retirement requires careful notice management under s.36 and removal of “holding out” risks; outgoing partners remain liable for past debts unless novated and are commonly indemnified by continuing partners.
• Continuation and buy-out provisions prevent unintended dissolution on death or bankruptcy and should set valuation methods for goodwill and work in progress.
• On dissolution without continuation, assets are applied in the statutory order (s.44): outside creditors, partners’ advances, partners’ capital, then surplus according to profit sharing.

Key Terms and Concepts

• capital contribution
• profit sharing ratio
• management clause
• expulsion clause
• continuation clause
• partnership property
• personal property
• indemnity clause
• restrictive covenant
• governing law clause