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Legal Foundations of Partnership Agreements

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Considering forming a business partnership? Discover the essential legal foundations of partnership agreements to ensure that your venture starts on solid ground.

Business partnerships are a useful and beneficial tool to use in starting, maintaining, and growing a business given that shared enthusiasm, combined resources, and dual-sided investment can increase the chances of success for your venture. However, it is important to also consider the other side of the picture. Statistics reveal that around 70% of business partnerships ultimately fail due to misunderstandings, unresolved conflicts, unclear expectations, or mutual disagreements. 

While this may tempt you to reconsider the idea of business partnerships, there’s a vital safeguard to explore: Partnership Agreements. By establishing a clear and comprehensive agreement, you can protect your business and relationships while reaping the benefits of the partnership. It can be easy to avoid potential future conflicts by carefully drafting your partnership agreement and making sure that it is a good fit for your specific situation. 

A Quick Overview of Partnership Agreements

Partnership agreements are a legal framework that governs how a business is managed under the leadership of two or more people. It outlines the roles, responsibilities, and expectations of all parties involved. The primary aim of this legal document is to protect the interests of each partner and prevent any potential legal disputes.

The 4 Major Types of Partnership Agreements

The following are the major types of partnership agreements:

  1. General Partnership (GP): In this form of a partnership agreement, all the partners are equally liable for the debts of the business and possess similar rights regarding the management of the business. In Ontario, a general partnership does not need to be registered or submitted to any governmental authority to legally exist. Despite this, it is still highly recommended to have the partnership agreement in writing as it is a crucial legal tool to protect the interests of all parties involved in the partnership. 
  2. Limited Partnership (LP): This kind of partnership generally involves two entities: a general partner and a limited partner. General partners are responsible for the management of business affairs and are liable for the business debts. Contrarily, a limited partner doesn’t participate in routine operations and their liability is restricted to their investment.
  3. Limited Liability Partnership (LLP): LLP agreements are especially popular among professional services firms such as law and accounting practices. In this partnership, all parties possess limited liability which means that they are not personally liable for the debts or misconduct of other partners.
  4. Limited Liability Limited Partnership (LLLP): The Limited Liability Limited Partnership is a relatively newer and less common type of partnership. It combines the benefits of an LP and an LLP by providing liability protection to both general and limited partners.

Essential Components of a Partnership Agreement

A well-drafted partnership agreement includes the following essential components:

  1. Capital Contributions
    • Capital contributions refer to the initial investment made by each partner. The agreement should clearly address this aspect and establish the rules for the management of any current and future contributions. Additionally, there should be specifications included that discuss the frequency of profit distributions (monthly, quarterly, annually).
  2. Profit Share
    • Profit sharing provisions depend upon the percentage of ownership of an individual partner in the business. For instance, if there are two partners each owning 50% shares, then the profit shall be divided equally. However, if you desire a different arrangement, you must mention it in the agreement.
  3. Decision-Making Authority
    • The partnership agreement should specify whether decision-making is based on unanimous consent or through a majority vote. This helps prevent disputes and ensures that all partners understand their rights and responsibilities.
  4. Management & Governance
    • Who will manage day-to-day operations? How will major business decisions be made? These concerns, generally regarded as the management structure of the partnership, must be addressed in the agreement. 
  5. Non-Compete and Confidentiality Agreements
    • Partnerships can face challenges if partners are found to be misusing confidential business information or trying to compete with the business itself. To protect yourself and your business from these risks, it is important to include clauses on both confidentiality and non-compete agreements within your partnership agreement. The confidentiality clause will protect sensitive business information from being disclosed while the non-compete clause will ensure that partners are barred from engaging in competing activities for a certain amount of time or within a certain amount of distance once they leave the partnership. These provisions help to maintain trust between the parties and protect the interests of all partners involved. 
  6. Exit Strategy & Dissolution
    • A partner may consider exiting the partnership for a variety of both personal and professional reasons. To regulate this process, a partnership agreement typically includes an exit strategy. This includes conditions under which the partnership may end and steps for closure or transfer of the exiting partner’s stake in the business ownership.
  7. Death of a Partner
    • A partner’s death can disrupt the continuity of a partnership. Therefore, it’s crucial to include provisions in the agreement that address this scenario. These provisions should cover the rights of the deceased partner’s estate and whether the other partners can buy out the deceased partner’s share.

Drafting a Partnership Agreement

Drafting a partnership agreement is very important step in creating a business and requires serious consideration and communication between all parties involved. Here’s a quick outline of the process:

  1. Preliminary Chats: Before you start drafting the agreement, it is important to have open conversations with your partners about your vision, goals, and expectations for the partnership.
  2. Get Legal and Financial Advice: It is important to consult with experienced legal and financial advisors when creating your partnership. These advisors will give you insight into the legal requirements and financial implications of the partnership agreement. They’ll also help you identify potential issues you may not have thought of.
  3. Drafting the Agreement: You can then use the information from your preliminary chats and the expert advice from advisors, start drafting the partnership agreement. This document should include the components we mentioned above.
  4. Review and Revisions: Following the creation of the first draft, all partners should review the document thoroughly. Partners may need several rounds of discussions and revisions to finalize the agreement.
  5. Legal Review: Once all partners are happy with the draft, have it reviewed by a lawyer. This will ensure the agreement complies with local laws and regulations and all legal bases are covered. It is also important to advise your partners to conduct their own review of the document with their own independent lawyer to ensure that everyone’s interests are equally protected. 
  6. Signing the Agreement: Upon final approval by all partners and their legal advisors, sign the agreement. It’s a good idea to have the signing witnessed by a third party to avoid any disputes about its authenticity in the future.
  7. Storing the Document: Once signed, store the partnership agreement somewhere safe. Each partner should have a copy and another copy should be stored in a lawyer’s office or a safe deposit box.

Legal Implications of Partnership Agreements

Partnership agreements play a critical role in the formation and operation of a business partnership, and their implications under the law are substantial. Here’s a detailed look at how these agreements are interpreted and enforced legally as well as the impact of violation:

Interpretation under Law

Partnership agreements are considered binding agreements once they are signed by the parties involved. If any dispute arises, courts will generally act upon the plain language of the agreement if it is determined to be clear and unambiguous. However, if the agreement language is unclear, courts may look beyond the agreement to the actions and communications of the partners to determine their original intent.

Consequences of Breaches of Agreement

Breach of a partnership agreement can have serious legal implications. Punishments may include monetary compensation for any loss suffered. In extreme cases, it can lead to the partnership being terminated by one partner or as a court-ordered solution to ongoing disputes.

Wrapping Up

To wrap it all up, a well-drafted partnership agreement that is based on a solid legal framework is crucial for the success and stability of a business partnership. By establishing clear roles, responsibilities, and expectations, partners can ensure a profitable collaboration, navigate potential disputes, and ultimately achieve their shared goals.