The word “partnership” tends to give the impression of a simple and harmonious relationship. In the case of legal partnerships, however, while they do offer a reasonably flexible business structure in comparison with other English law alternatives, the legal framework that governs them is not as straightforward as the name might suggest.
The definition of a business partnership is contained within section 1 of the Partnership Act 1890 (“the Act”), which remains good law today. A partnership is defined in the Act as “the relation which subsists between persons carrying on a business in common with a view of profit”. The Act sets out, amongst other things, a default regime concerning the running of a partnership which will be implied into a partnership agreement in the absence of any express provisions.
We recently advised on a dispute in the context of a medical practice that had been set up as a two-partner partnership. In this case, there was a binding (albeit very rudimentary) partnership deed which governed the relationship between the parties so the default regime set out in the Act was kept at bay.
Following a close inspection of the partnership accounts, and much to the dismay of our client, (“Partner A”), an alarming number of unauthorised and therefore unlawful transactions were discovered. The accounts revealed that for a period of over two years the second partner, (“Partner B”), had been repeatedly defrauding the partnership.
The catalogue of breaches included over-payments to Partner B’s family members (who were also employed by the medical practice) and a number of substantial over-drawings. On top of this, Partner B had charged personal expenses to the partnership account, including hire car payments, mobile phone bills and unauthorised cheques. Over the course of two years, and in clear breach of the partnership deed, Partner B had defrauded the partnership to the tune of more than £200,000.
We were instructed to move quickly against Partner B. The conventional route would have been to apply to court for a freezing order to prevent further fraudulent activity. However, we looked for ways to find a more cost-effective solution. We realised that if the partnership’s bankers realised that there was a partnership dispute they would freeze the account (as banks do in these circumstances to avoid claims against them by either or all partners). If Partner A could find a line of cash to run the practice for a short period we could lock Partner B out of the account for no legal cost. The bank was notified of the dispute and immediately froze the partnership’s bank accounts, and changed the locks at the property. We succeeded in removing Partner B from the partnership, on our client’s terms, by entering into a confidential deed of settlement that required Partner B to exit the partnership by voluntary resignation.
However, in terms of the existence of a partnership, it is a rule that an entire partnership will automatically dissolve where only one partner is ‘left standing’. This is because a partnership must have more than one partner in order to satisfy the definition in section 1 of the Act. It would have caused enormous disruption to our client’s business if the partnership was dissolved. We formulated a strategy to combat this and the sequence of events was critical.
First, we arranged for a new partner to be appointed and, immediately after that appointment, having drafted and agreed the deed of settlement with Partner B in advance, we ensured Partner B exited the partnership by voluntary resignation by completing the deed of settlement immediately after the new partner was appointed. We also took the opportunity to draft a much improved partnership agreement tailored to the medical practice’s future business needs.
Our client succeeded in ridding itself of an unethical partner and was delighted that we were able to arrive at this outcome without having to resort to litigation which would have been expensive, time consuming and would have led to the dissolution of the partnership.
If you find yourself caught up in a partnership dispute, having the benefit of pragmatic, strategic advice can help resolve a complex matter swiftly, whilst minimising the disruption to your business.
Authored by Alex Cochrane, a senior associate, and Nicole Phillips, a trainee solicitor.