A partnership has two or more individuals that operate a business as co-owners. Not all states have adopted statutes regulating partnerships. Any form of legal partnership should have at least one written agreement. Otherwise, the parties may be in collaboration with each other. They would share profits without any kind of formal status.
The elements in a partnership agreement discuss the conditions of business operation. Their purpose is to ensure fairness among partners.
A Breakdown of the Partnership Elements
A Partnership Agreement provides the partners with the following protections:
- Separate Legal Entity for the Partnership
- Agreement on Termination of the Partnership
- Rights and Obligations of All Partners in Management and Profit-Sharing
- Assignment of Interests in the Partnership
- Settlement of Disagreements among Partners
- Protection Against Partner’s Misconduct or Bankruptcy
- Tax Treatment of Profits & Losses Within the Partnership
- Distribution of Limited Liability Among Partners
- Powers Granted to Individual Managing Partner(s) or Managers
- Dissolution of the Partnership
1. Separate Legal Entity for the Partnership
The partnership contract should state that each partner is an agent of the company. When they conduct business activities, they are acting on behalf of the partnership. It provides legal protection to each partner in case a third party has any personal claims. Shareholders or creditors cannot claim other partners’ personal property in individual lawsuits.
2. Agreement on Termination of Partnerships
Often when many partners are in business, disagreements may arise over decisions. Other issues could be management and operation roles, responsibility-sharing, and equity distribution. Also, treatment of creditors and how to treat financial losses should be taken into account.
It is better to address such differences in the initial agreement. It will allow the parties to fix issues without having to dissolve their business.
3. Rights and Obligations of All Partners
The agreement should set out the rights and obligations of all partners. For example, each partner has a right to participate in management decisions.
This includes the right to inspect books and records. They may be required to contribute capital to the venture or take part in decision-making.
4. Assignment of Interests (Assignability)
At times, a partner may want, temporarily or permanently, to transfer their interest back into the business. It could be because they want to take an extended leave of absence, go on a vacation, or for whatever reason.
Without this clause, other partners could deny that request and force the individual to sell their interest back to the company. This would complicate matters. It is because it could bring ill feelings among partners. Mostly, those who are not aware of this arrangement beforehand.
5. Settlement of Disagreements Among Partners
It is important for all partners to come to some sort of decision-making arrangement. It should cover how the resolving disagreements among partners. It will state whether they want mediation by another partner or prefer arbitration by outside entities. Whatever their preference, it needs to be stated within the partnership agreement.
6. Protection Against Partner’s Misconduct or Bankruptcy
All partners should be covered by the protection of the agreement. It is in case a partner decides to get involved in misconduct like getting involved in illegal activities or declaring bankruptcy.
This clause is known as an “insolvency” or “misconduct” clause. It will allow for the business to buy out the partner’s interest in such a situation.
7. Tax Treatment of Profits & Losses Within the Partnership
Partners must decide how profits and losses will be shared at the end of their fiscal year. There are different ways that this can be handled. It depends on whether they want each partner to contribute equally, based on work effort.
8. Distribution of Limited Liability Among Partners
Sometimes it is important to have a distinction among all partners. It could be as far as their level of liability is concerned. This extends to the amount each partner contributes to the business.
9. Use of Partnership Name
Here, what is important is to state whether each partner has the right to use the partnership name and if they can rebrand it, so it doesn’t represent any individual.
10. Dissolution of Partnership
It is important that the terms of how to dissolve a partnership are stated. Depending on the size and volume of business, partnerships can dissolve in different ways. For example, if all partners agree or by having one partner buy out another partner.
Now you understand the elements to include in a partnership contract. Contact your legal advisor for more information.
Author name– Alison Lurie