Breaking up is hard to do
24 May 2004
16 May 2012
2 October 2006
31 March 2003
23 March 2011
10 May 2004
When an individual is asked to become a full equity partner, rarely will the new partner turn their mind to the terms of the partnership agreement, nor is the partner likely to consider the possibility of failure. However, today a legal career at only one firm is becoming the exception rather than the rule. In this context, what happens when things go wrong and the majority of the partners want an individual partner out?
Section 25 of the Partnership Act 1890 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”. Likewise, unless it has been agreed between the partners, neither the Partnership Act nor the general law provide a general right to retire without forcing the dissolution of the partnership.
When no right to expel is conferred by the partnership agreement, if the majority of the partners want to remove a partner from the partnership, their options are limited. If the partnership agreement provides a right to retire, then they might seek the partner’s ‘voluntary’ retirement from the partnership. If there is no right to retire and/or the partner is not willing to go, then the remaining partners must, in accordance with Section 35 of the Partnership Act, seek the dissolution of the partnership by the court. The grounds upon which the court may decree the dissolution include:
- the permanent incapacity of a partner;
- conduct by a partner that is calculated to prejudicially affect the carrying on of the business;
- a wilful or persistent breach of the partnership agreement;
- conduct by a partner relating to partnership business, which renders it not reasonably practicable for the other partners to carry on the business in partnership with that partner;
- any other circumstances that render it just and equitable for the partnership to be dissolved.
Dissolution of the partnership is often not a viable option for the remaining partners. Likewise, law firms do not want their internal disputes aired in a public court. It is therefore advisable to make provision in a partnership agreement for the expulsion of a partner.
It is vital for a partnership agreement to state concisely the exact grounds upon which a partner can be expelled, the procedure that must be adopted and the financial implications that follow an expulsion. Importantly, there must be a final settlement of accounts between the partners, failing which, in accordance with Section 42 of the Partnership Act, the expelled partner will retain certain rights to share in the profits.
Traditionally, the grounds for expulsion have included bankruptcy of the partner, mental or physical incapacity, a breach of the agreement or misconduct. However, it is becoming common practice to find compulsory retirement clauses that are, in effect, ‘no fault’ expulsion clauses.
A partnership agreement should stipulate who has the right to exercise the power to expel. Where the partnership agreement stipulates the procedure to be followed, that procedure should be adhered to strictly. If the issue is to be discussed with other partners prior to the vote so as to encourage the majority of partners to exercise the right of expulsion, then as a matter of good faith the partner who faces possible expulsion should also be given a right to address all fellow partners on the topic. If a partner is being expelled on specific grounds, then the expulsion notice should specify that wherever possible, it is best to avoid giving detailed reasons. Once the reasons have been given, the justification for the decision is then open to attack.
Alan Watts is a litigation partner at Herbert Smith