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7 November 2013
Commercially speaking, the meanings of partner are manifold. Tim Marshall cites two recent cases that indicate clearly the need for pen-and-ink clarity from the outset
There are advantages and disadvantages to adopting a partnership structure for a business. Being a partnership, the business owners necessarily share the profits, the liabilities and the decision-making, which can be a huge advantage, especially where partners have different skills and can work well together. A partnership is generally easier to form, manage and run.
Partnerships are regulated less strictly than companies, both in terms of the laws governing their formation and because partners have the only say in the way the business is run, without interference by shareholders. They are also far more flexible in terms of management, so long as all the partners can agree.
The main drawback of partnerships is unlimited liability, whereby each of the partners shares the liability and financial risks of the business. This can be countered by the formation of an LLP, which benefits from the advantages of the limited liability granted to limited companies while taking advantage of the flexibility of the partnership model.
If a partnership model is adopted, there will often be partners and employees carrying on the business. The term ’partner’ can denote a variety of positions. Someone described as a partner may be a salaried partner, a fixed-share partner, an equity partner, an LLP member or in fact an employee. The name given to a relationship does not in itself determine its status.
However, establishing whether someone described as a partner is an employee or a true partner is important for a number of reasons. It is necessary to determine the individual’s rights and duties, as employees benefit from statutory employment protection, including unfair dismissal rights. True partners owe the more onerous duty of good faith, while employees are subject to the lesser implied obligation of mutual trust and confidence.
The status of an individual will also affect the tax treatment of remuneration and any exit package.
There’s a limit
Legislation governing partnerships provides limited assistance in determining status. Section 4(4) of the Limited Liability Partnership Act 2000 (LLPA) states: “A member of a limited liability partnership shall not be regarded for any purpose as employed by the limited liability partnership unless, if he and the other members were partners in a partnership, he would be regarded for that purpose as employed by the partnership.”
In other words, an individual has to fall within the definition of a partner under the act to be regarded as a self-employed member under the LLPA. Section 1 defines partnership as “the relation which subsists between persons carrying on a business in common with a view of profit”.
Case law suggests that a variety of factors need to be considered. The factors that will tend to point to partnership status include the entitlement to a share of residual profit, a requirement to contribute equally to any losses the business sustains and an obligation to contribute a sum of capital to the business.
Partners also usually have the right (although not necessarily the exercise of the right) to participate in the governance and administrative processes of the firm; and the right to have access to, inspect and copy any of the partnership books. They also have the right to be authorised signatories for the business, for example when dealing with the bank account, as well as the right to hire and fire employees.
Normally partners also have accession to the partnership agreement or deed and the right to veto the introduction of new partners. Unless confirmed otherwise in the agreement, a new partner can only join the business with the consent of all existing members.
Contradictions in terms
On dissolution of the partnership partners have the entitlement to a proportion of the profit, regardless of the amount, and they get different treatment from employees in relation to hours, holiday, sickness absence and disciplinary issues.
None of these factors are determinative, but the presence of one or more will tend to suggest partnership status. However, applying these factors to particular situations can be difficult, and two recent cases have resulted in what appear to be conflicting decisions.
In Tiffin v Lester Aldridge LLP (2010) the Employment Appeal Tribunal held that a fixed-share member of an LLP who enjoyed limited voting rights and profits was a member, not an employee. The fact that their share of profit and their decision-making powers were limited did not point away from them being a member.
However, in Williamson & Soden Solicitors v Briars (2011), a solicitor who was entitled to a profit share was held to be an employee.
The partnership and Mr Williamson entered into an arrangement whereby, instead of him being paid a salary of £55,000 per year, he would be paid a guaranteed profit share of £55,000 together with an 18th of the net profit of the firm - potentially a further £10,000. But the benefits of the existing contract were to continue as before: he had no risk of losses and no capital stake in the firm, was required to meet targets and was not consulted about significant events such as an impending audit by the SRA.
These cases show that, if the intention is that an individual should be a partner, the starting point should be a clear partnership or membership agreement.
This will not only help to determine the nature of the relationship, but also to regulate rights and duties between the partners.
Tim Marshall is a partner at DLA Piper