You already have a partnership agreement

If you are in business with somebody else in Scotland and neither of you ever signed anything, you are not operating without an agreement. You are operating under the one the Partnership Act 1890 wrote for you. Every rule set out below applies unless the partners have agreed otherwise, and most of them are not what people assume.

That is why the useful question is not “what should go in a partnership agreement”, which is the list every firm publishes. The useful question is what the Act is currently deciding on your behalf, and whether you are content with it. Read what follows and you will know which of these defaults you can live with and which one is the reason to instruct somebody.

One point before the detail. Section 19 provides that the mutual rights and duties of partners, whether ascertained by agreement or defined by the Act, may be varied by the consent of all the partners, and that such consent may be either express or inferred from a course of dealing. So a deed signed in 1998 is not necessarily the deal you are on today. If the partners have consistently behaved on a different footing for years, that conduct can matter.

Profits are shared equally, whatever you each put in

This is the default that surprises people most, and it is the first thing to check.

Section 24(1) provides that all the partners are entitled to share equally in the capital and profits of the business, and must contribute equally towards the losses whether of capital or otherwise sustained by the firm. Equally. Not in proportion to what each partner contributed, not weighted by who brought in the premises or the machinery or the client list.

If one partner put in £200,000 and the other put in £20,000, and nothing was agreed, the starting position is an equal division of capital and profits and an equal share of the losses. The partner who funded the business is not entitled to interest on the capital he subscribed before profits are ascertained either, because section 24(4) says so. He is entitled to interest at five per cent on any actual payment or advance he makes beyond the capital he agreed to subscribe, under section 24(3), but that is a different thing and it depends on the advance being beyond the agreed subscription.

What an agreement can do: specify unequal shares of capital, profit and loss to match what each partner actually contributed, and deal separately with interest on capital and on advances. A single clause fixes all of this. Its absence is the most common reason a Scottish partnership accounting turns into a dispute years later, by which time the contemporaneous evidence of what was intended has usually gone.

The partner doing all the work is not paid for it

Section 24(6) provides that no partner is entitled to remuneration for acting in the partnership business. Under the default rules, the partner who runs the place six days a week and the partner who appears on a Thursday take the same share.

Alongside that, section 24(5) provides that every partner may take part in the management of the partnership business. There is no default concept of a senior partner, a managing partner or a sleeping partner. If you want one, it has to be written down.

Section 24(9) provides that the partnership books are to be kept at the place of business, or the principal place if there is more than one, and that every partner may, when he thinks fit, have access to and inspect and copy any of them. That is a broad right and it does not soften when relations deteriorate. Partners who assume they can control access to the accounting system during a fallout are usually mistaken.

What an agreement can do: provide for drawings, a salary or a management fee for the partner who runs the business, allocate authority between the partners, and define which decisions are reserved to all of them.

Who decides what, and who can join

Section 24(8) splits decisions in two. Any difference arising as to ordinary matters connected with the partnership business may be decided by a majority of the partners. But no change may be made in the nature of the partnership business without the consent of all existing partners. So a majority can run the business; only unanimity can change what the business is.

Section 24(7) is stricter still: no person may be introduced as a partner without the consent of all existing partners. In a firm of three, one partner can block the admission of a fourth indefinitely, and there is no default mechanism to break that. In a family business where the next generation is expected to come in, the absence of a written admission procedure is a problem waiting to happen.

What an agreement can do: set out an admission procedure, including who may be admitted, on what terms, and by what majority.

You cannot expel a partner unless you agreed you could

Section 25 provides that no majority of the partners can expel any partner unless a power to do so has been conferred by express agreement between the partners.

Read that again, because it is the clause whose absence causes the most damage. If there is no written agreement, or the agreement contains no expulsion power, then however serious the misconduct, the other partners cannot vote a partner out. What is left is an application to the court for dissolution under section 35, which ends the firm rather than removing the individual, and which is slow and expensive.

What an agreement can do: confer an express power of expulsion, which is the only way one can exist. Such a clause has to be drafted with care and it is construed strictly against the partners seeking to use it. But having one, with defined grounds and a proper procedure, is the difference between a manageable problem and a court action.

Any partner can end the firm on notice

Section 26(1) provides that where no fixed term has been agreed for the duration of the partnership, any partner may determine the partnership at any time on giving notice of his intention to do so to all the other partners. Section 26(2) adds that where the partnership was originally constituted by deed, a notice in writing signed by the partner giving it is sufficient.

Section 32(c) produces the same result on the dissolution side, and section 33(1) provides that, subject to any agreement, every partnership is dissolved as regards all the partners by the death or bankruptcy of any partner.

So under the default rules the firm is fragile in two directions at once. It can be ended deliberately by any partner who has fallen out with the others, and it can be ended by an event nobody chose.

What an agreement can do: fix a term, or provide a retirement mechanism with notice; and provide for the business to continue on a death, retirement or bankruptcy, with machinery for valuing and paying out the outgoing partner’s share. That continuation and buy-out machinery is the single most valuable thing a partnership agreement does.

What partners owe each other by default

Three sections set the baseline, and a good agreement builds on them rather than repeating them.

Section 28 provides that partners are bound to render true accounts and full information of all things affecting the partnership to any partner or his legal representatives.

Section 29(1) provides that every partner must account to the firm for any benefit derived by him without the consent of the other partners from any transaction concerning the partnership, or from any use by him of the partnership property, name or business connexion. Section 29(2) extends that to transactions undertaken after a partnership has been dissolved by the death of a partner and before its affairs have been completely wound up.

Section 30 provides that if a partner, without the consent of the other partners, carries on any business of the same nature as and competing with that of the firm, he must account for and pay over to the firm all profits made in that business.

What the Act does not give you is any restriction on what a partner does after he leaves. Post-termination restrictive covenants are a matter of agreement, and they are subject to the ordinary Scots law on restraint of trade, which means they must be no wider than is reasonably necessary to protect a legitimate business interest.

What an agreement can do: define the scope of permitted outside interests while the partnership subsists, and impose restrictions after a partner leaves, within the limits the law allows.

The Scottish point: heritable property in the partnership

Section 22 of the 1890 Act provides that where land, or any heritable interest in land, has become partnership property, it is treated as between the partners, including the representatives of a deceased partner, and also as between the heirs of a deceased partner and his executors, as moveable and not heritable estate, unless a contrary intention appears.

It is a Scottish provision in practical terms. Section 22 was repealed for England and Wales with effect from 1st January 1997 by the Trusts of Land and Appointment of Trustees Act 1996, and it continues to apply in Scotland.

What it does needs stating carefully, because it is easy to overstate. Where a farm or other heritable property is genuinely partnership property, section 22 treats the partners’ interests in it as moveable rather than heritable for these succession purposes. That does not mean the land itself somehow stops being heritable property, or that title simply passes to the executor. Section 20(2) preserves the ordinary rules governing title to heritable estate. The distinction can nevertheless matter sharply on death, including because a deceased partner’s partnership interest can fall into the moveable estate against which Scottish legal rights operate.

For a farming family that is the point to take advice on. Whether the land has become partnership property at all is a question of fact and intention under section 20, and the answer usually turns on the title, the accounts and what the partners actually did rather than on what anybody now says was meant. The words “unless the contrary intention appears” in section 22 are doing real work, and a partnership agreement is the obvious place to make that intention plain.

What an agreement can do: record expressly whether heritable property is partnership property, or is owned by an individual partner and merely occupied by the firm, and state the intention that section 22 preserves. That is the difference between a settled position and an argument between an executor and the surviving partners.

What to do

Find out whether an agreement exists. Look for a deed, a minute of agreement, or correspondence in which terms were confirmed. If it exists, read it, and then consider whether the partners have in fact been operating on different terms, because section 19 means a course of dealing can vary it.

Check the profit-sharing position first. If the capital contributions were unequal and nothing was agreed, section 24(1) is currently dividing capital and profits equally, and that is the issue most likely to be worth money.

Establish whether there is an expulsion power and a continuation provision. If either is missing, the firm has no orderly way of dealing with a partner who has to go, or with a partner who dies.

Deal with heritable property expressly. If land is or might be partnership property, section 22 and section 20 need to be addressed in the document rather than left to be argued about later.

Do it while everybody still agrees. A partnership agreement negotiated between partners who are getting on takes a fraction of the time and cost of an accounting negotiated between partners who are not, and it is the same lawyers doing the work either way.