Month: December 2020

Basic requirement

All limited liability companies are required to register at Companies House and deliver a confirmation statement to the Registrar of Companies each year detailing any changes to the shareholders and their shareholdings and the directors (and company secretary if there is one). A company is also required to make certain filings at Companies House when it changes such things as its articles, officers, registered office, accounting reference date and share capital. Companies are also required to file annual accounts. All of this information is publicly accessible on the Companies House website. Solicitors practising in the area of company law frequently need to access this information in order to advise their clients.

People with significant control

From 6 April 2016, the ‘people with significant control’ (‘PSC’) regime came into effect in the UK, obliging most UK companies (and LLPs) to maintain a register of PSCs and from 30 June 2016 to supply to Companies House the information on this register along with the company’s confirmation statement, which replaces the previous annual return that companies were required to file. New companies need to supply this information on incorporation.

The PSC regime is set out in Part 21A Companies Act 2006 (CA 2006). It applies to all UK companies apart from those with shares listed on the Main Market of the London Stock Exchange (as these companies are already subject to similar requirements under the LPDT rules. To be a PSC, an individual must meet one or more of the five conditions set out in Part 1 of Schedule 1A CA 2006, which are set out below. Where the owner or controller of a UK company is a legal entity such as a company or LLP, that legal entity will need to be put on the PSC register if it is a registrable relevant legal entity (‘RLE’).

Definition of PSC (Part 1, Schedule 1A CA 2006)

A person with significant control over a company is an individual who meets one or more of the following conditions:

• The person holds, directly or indirectly, more than 25% of the shares in the company;
• The person holds, directly or indirectly, more than 25% of the voting rights in the company;
• The person holds the right, directly or indirectly, to appoint or remove a majority of the board of directors of the company;
• The person otherwise has the right to exercise, or actually exercises, significant influence or control over the company;
• The person has the right to exercise, or actually exercises, significant influence or control over an arrangement such as a trust, which is not a legal entity but which meets any of the other specified conditions in relation to the company or would do so if it were an individual.

Definition of RLE

Where an owner or controller of a UK company is a legal entity, it will need to be put on the company’s PSC register if it is an RLE. This depends on two factors:

• It would have met one of the conditions for being a PSC if it had been an individual and is itself an entity that is subject to the PSC regime or is a listed company; and
• It is the first relevant legal entity in the company’s ownership chain.

For example, if a UK company, A, is wholly owned by another UK company, B, only company B needs to be entered on company A’s PSC register as a RLE. It is not necessary for A to trace ownership up the corporate chain beyond B (for example, if B is wholly owned by company C, company C does not need to appear on the PSC register of company A). This is because information about the ownership of company B can be found on B’s PSC register.

Duty and sanctions

Section 790D CA 2006 imposes a duty on companies to take reasonable steps to identify their PSCs and RLEs. Failure to do so is a criminal offence, which can be committed by the company and any officer in default, with a maximum penalty of a fine or up to two years’ imprisonment. There is also a duty on PSCs and RLEs to notify the company of their status within one month of becoming a PSC or RLE, and it is also a criminal offence to fail to do so (s.790G CA 2006). Companies, PSCs and RLEs also have a duty to keep the company’s PSC register up to date by serving notice as soon as reasonably practicable if a change in circumstances occurs. From 26 June 2017, entities have to update their PSC register within 14 days of any changes and notify Companies House within another 14 days. This requirement was introduced as a result of changes to the UK’s anti-money laundering legislation.

Share capital and the principle of maintenance of share capital

Companies can raise finance by issuing shares. A company’s share capital is divided into individual shares and s.542 Companies Act 2006 (CA 2006) requires that each share has a fixed nominal value, sometimes referred to as a par value. One of the most common nominal values for private limited companies is £1. As an example, a company may have a share capital of £100,000 divided into 100,000 shares of £1 each.

The nominal value of a share does not usually bear any relationship to the market value of that share. For this reason a person wishing to subscribe for shares in a company may be required to pay more than the nominal value for those shares. If an investor pays more than the nominal value when subscribing for shares, the extra amount paid, over and above the nominal value, is referred to as the premium and such shares are said to be ‘issued at a premium’.

A company’s issued share capital is regarded as a permanent fund available to creditors. The amount paid up on the issued share capital of a company is a fund of last resort available to creditors should the company fail. To maintain this fund of last resort, a company is not allowed to return the share capital to shareholders except in certain limited circumstances. This is known as the principle of maintenance of capital and is one of the key principles of company law. However, many private companies have a relatively small share capital and in such cases the protection for creditors will be very limited. In any event, it is wrong to think that the money which shareholders have paid for their shares is somehow locked away, to be brought out when creditors need to be paid. The money which shareholders pay for their shares will be used by the company for its business and corporate purposes.

The separate personality of a company

A company is an entity that is distinct from its owners – the shareholders – as well as from its directors, creditors and employees. It has a separate legal personality with its own rights and obligations. A company continues to exist even if its shareholders and/or directors change. This is a fundamental concept of company law, since there is always an extra entity to take into account: the company.

Directors, in general, owe their duties to the company, not to the shareholders. Shareholders usually have rights against the company, rather than against the directors, and third parties with whom the company does business contract with the company, even though they negotiate with the directors.

Limited liability

Limited liability does not mean that the company’s liability is limited; it means that the shareholders’ liability (i.e. shareholders’ responsibility for the company’s debts) is limited. The creditors to whom the company owes money can assert their rights in full against the company but if the company has insufficient funds to meet its liabilities the company’s creditors cannot then pursue their claims against the shareholders.

If their company goes into an insolvency procedure (such as liquidation or administration), the shareholders will be liable to lose the money that they have invested in the company by subscribing for its shares but that is the extent of their liability.

Limited companies as popular commercial vehicles

Limited liability is the quality that has caused companies to become such useful commercial tools. The personal assets of shareholders are distinguished from the assets of the company. The concept of limited liability is fundamental to:

1. passive investment: the shareholders can invest in a company following an assessment of the risks of losing that investment, knowing that the rest of their personal assets is safe and without having to take an active role in management;
2. why many entrepreneurs seek to conduct business through the medium of a limited liability company; and
3. why groups of companies have developed: riskier business divisions can be conducted through separate companies within the group without the less risky companies becoming vulnerable to creditors of the riskier companies.

Section 74 Insolvency Act 1986 enshrines the concept of limited liability, confirming that the shareholders of a limited company are, generally speaking, not liable to contribute towards the debts of the company following it going into
liquidation expect to the extent they owe money for the purchase of their shares.

Limits to the doctrine of limited liability

Note that it is possible to incorporate unlimited companies and also that there are limits on the doctrine of limited liability, both commercially and legally. In certain, much debated, situations the court can ‘pierce the corporate veil’ in the interests of justice, for example if the company is considered a façade.

There are however many devices which creditors can employ to try to improve their position. This is usually by contractual means. Properly entered into, these contracts are effective and enforceable: for example a creditor can require a guarantee from the shareholder(s) of a company, which will then circumvent the limited liability of the shareholder(s). The use of these strategies comes down to commercial factors: the bargaining power of the parties and the ingenuity of their advisors.

It is only possible to grasp why these devices are needed if you can appreciate the underlying fundamental concepts of limited liability of shareholders and the separate legal personality of a company.

Introduction

For those of you looking for a short summary of limited companies, below are the salient points to remember:

• A company is an entity that is distinct from its shareholders; it has a separate legal personality.
• The shareholders are the owners of a company whilst the directors manage the company on a day-to-day basis.
• Limited liability means that the liability of the shareholders for the liabilities of the company is limited, not that the liability of the company is limited.
• The doctrine of maintenance of share capital means that when companies raise money by issuing shares, the money paid for those shares by the shareholders should not be returned to them except in a solvent liquidation after all creditors have been paid in full.
• The PSC regime requires that companies identify and keep a register of people with significant control in the company.
• The Companies Act 2006 (CA 2006) sets out minimum rules which a company has to follow and the company’s Articles can then apply more rigid or detailed systems of management to the extent allowed by the CA 2006.
• Most companies have articles based on the Model Articles or Table A (the default articles under the CA 2006 and the Companies Act 1985 (CA 1985) respectively).
• Directors must exercise their powers in accordance with their statutory duties under ss.171– 177 CA 2006 and these duties are owed to their company.
• The CA 2006 applies to all types of companies but, in general, private companies enjoy lighter regulation than public companies. Only private companies are able to pass shareholder resolutions using the written resolution procedure.
• Subject to certain conditions, public companies are permitted to offer their shares to the public and a minority of public companies are listed on the Official List which means that their shares can be traded on the Main Market of the London Stock Exchange.
• The provision of financial services in the UK is regulated by Financial Services and Markets Act 2000 (FSMA 2000) and Financial Services Act 2012 (FSA 2012).
• It is a criminal offence to engage in regulated activities (s.19 FSMA 2000) or financial promotions (s.21 FSMA 2000) without appropriate authorisation or to engage in insider dealing (s.52 Criminal Justice Act 1993 (CJA 1993)) or to make misleading statements or impressions in connection with a sale of shares (ss.89 & 90 FSA 2012).
• It is a civil offence to engage in market abuse (under MAR).
• Listed companies and their subsidiaries have to comply with certain continuing obligations (i.e. continuing after their shares have been listed) with a view to maintaining an orderly market in their shares.

Introduction to Limited Liability Partnerships

A Limited Liability Partnerships (LLP) is a hybrid vehicle. This means it has elements of both a company (legally it is a body corporate and is treated as a separate legal entity from its members: s.1(2) Limited Liability Partnerships Act 2000 (LLPA)) and a partnership (it is treated as tax transparent).

Consequently, an LLP has the flexibility of a partnership with the added advantage of limited liability for its members. Because an LLP is a body corporate, it has a legal personality which is separate to that of its members. As a result, it is liable for its own debts and is able to contract with third parties.

The LLPA was enacted for several reasons, chief of which was the perception amongst professional partnerships that as a result of the growth in litigation, the current partnership model, whilst having many commercially useful features, did not provide the kind of protection that was available to limited liability corporations (this is because partners in traditional partnerships have unlimited liability for the debts of the partnership). Other jurisdictions, such as the USA, had already led the way in dealing with these concerns by creating a hybrid business vehicle and the UK LLP model was drafted along broadly similar lines.

LLPs are increasingly important and many law firms are now run as LLPs. There are approximately 53,000 LLPs registered at Companies House (although this is still a small number in comparison to the number of companies so registered, approximately 4 million).

Applicable legislation

LLPs are incorporated pursuant to the LLPA. The LLPA is supplemented by two statutory instruments: the Limited Liability Partnerships Regulations 2001 (SI 2001/1090) (as amended) (the 2001 Regulations) and the Limited Liability Partnerships (Application of Companies Act 2006) Regulations 2009 (SI 2009/1804) (as amended) (the 2009 Regulations). The 2001 Regulations deal with insolvency and the internal governance of LLPs; the 2009 Regulations govern the corporate law aspects of LLPs. In particular, the 2009 Regulations apply provisions of CA 2006 to LLPs (with appropriate amendments). LLPs are primarily governed by a company (rather than partnership) law framework.

The Insolvency Act 1986 (IA) and the Company Directors Disqualification Act 1986 have, since LLPs were introduced, applied to LLPs in modified form. This has important consequences, so that, for instance, s.213 IA (fraudulent trading), s.214 IA (wrongful trading), as well as the disqualification of director provisions and the greater part of the insolvency and winding up procedures apply equally to LLPs and their members as for companies.

Setting up an LLP

Section 2(1)(a) LLPA states that two or more persons associated for carrying on a lawful business with a view to profit can incorporate an LLP. A ‘person’ in this context can be a company as well as an individual. The use of the word ‘business’ requires that there must be some commercial activity, so LLPs are not normally used by non-profit organisations as business vehicles.

Registration at Companies House

Form LL IN01

The subscribing members fill out a Form LL IN01, which is sent to Companies House with the relevant fee. The form must state, inter alia, the name of the LLP, its registered office’s address and which members, if not all of them, are to be designated members (s.2(2) LLPA).

A copy of a form LL IN01 can be viewed on the www.gov.uk website.

Certificate of Incorporation

Once registered, the Registrar of Companies issues a certificate of incorporation as conclusive evidence that all legal requirements have been complied with. The name of the LLP will be entered on the index of company names and it will be given a number.

Continuing Registration Regime

Once registered, LLPs are obliged to continue to file information with Companies House i.e. change of name, change of registered office, changes in membership, creation of a charge and annual confirmation statement. LLPs are subject to the Limited Liability Partnerships (Accounts and Audit) (Application of Companies Act 2006) Regulations 2008. These require LLPs to file accounts at Companies House.

In addition to its obligations to file information at Companies House, an LLP must maintain certain in-house records, including registers of its members and of its ‘people with significant control’ ([b]PSCs[/b] who are, broadly speaking, those with at least a 25% interest in the LLP).

The LLP Agreement

An LLP has no Memorandum and no Articles of Association. The LLPA and the 2001 Regulations do not lay down any particular management structure to be adopted, in contrast to companies. There is, therefore, greater flexibility with the management of an LLP.

Therefore, it is necessary in practice to have an LLP or Members’ Agreement stating how these issues are to be dealt with by the LLP and its members, in a very similar way to how a partnership agreement is designed to operate.

If there is no Members’ Agreement, various default provisions in regulations 7 and 8 of the 2001 Regulations will apply. Note that any other gaps will not be filled by partnership law, which is disapplied with respect to LLPs by s.1(5) LLPA.

Members of an LLP: Rights and Duties

As referred to in paragraph 4.3 above, the obligations that members of an LLP have to each other are best dealt with in a formal written Members’ Agreement. Such an agreement is a private document and would set out formal procedures and arrangements to which the members had agreed.

However, members of an LLP are not obliged to have a formal Members’ Agreement to regulate their relationship and in the absence of any such agreement, the 2001 Regulations contain eleven default provisions as set out below.

Regulations 7 and 8 of the 2001 Regulations

• Members share equally in capital and profits (Reg.7(1)).
• An LLP must indemnify its members for payments made and personal liabilities incurred by them in the ordinary and proper conduct of the business of the LLP (Reg. 7(2)).
• Every member may take part in management (Reg.7(3)).
• No member is entitled to remuneration for managing the LLP (Reg.7(4)).
• No person can become a member or assign their membership without the consent of all existing members (Reg.7(5)).
• Ordinary decision making may be by the majority of the members. Any proposed change to the nature of the business requires the consent of all the members (Reg.7(6)).
• The books and records of the LLP must be available for inspection by the members at the registered office (Reg.7(7)).
• Each member must give true accounts and full information of all things affecting the LLP to any member or his legal representative (Reg.7(8)).
• If a member (without consent) carries on any business of the same nature as, and competing with, the LLP then he must account for and pay over to the LLP all profits made by him in the business (Reg.7(9)).
• Every member has a duty to account for benefits derived from transactions with the LLP and its business or property (Reg.7(10)).
• There is no implied power of expulsion of a member by the majority unless the members have expressly provided for such a power in a Members’ Agreement (Reg.8).

Members

The members of an LLP are those who subscribed to the incorporation document and those who became members at a later date by agreement with the existing members. Section 4(2) LLPA provides that persons, not just individuals, can be members of an LLP. Therefore, corporate bodies may be members of an LLP.

An LLP must have at least two formally appointed members at all times. There is no limit on the maximum number of members an LLP can have.

At least two members of the LLP must be ‘designated members’. Their obligations include, amongst other things, appointing an auditor, signing the accounts on behalf of the members, making filings at Companies House and acting on behalf of the LLP if it is wound up.

Section 4(3) LLPA states that a member will cease to be a member of the LLP upon:

• his death;
• agreement with the other members of the LLP;
• giving notice to the other members of the LLP; or
• dissolution (if the member is a body corporate).

Summary of the Characteristics of LLPs

LLPs are a hybrid form of a partnership and a company, taking characteristics from both forms of business media.

Corporate Characteristics:

• separate legal personality;
• limited liability for members, subject to the restrictions mentioned above;
• LLPs have to file accounts at Companies House on much the same basis as companies, leading to a loss of financial privacy (which is one of the main attractions of using a partnership structure);
• LLPs, like companies, are capable of creating a floating charge (an important type of security interest) over the assets of the LLP, unlike a partnership; and
• some provisions of company law (in particular CA 2006) and corporate insolvency law (as contained in the Insolvency Act 1986 and the Company Directors Disqualification Act 1986) apply to LLPs in modified form.

Partnerships Characteristics:

• LLPs have no share capital or capital maintenance requirements;
• no real distinction between members and the management board (unlike a company, in which the members/shareholders and board of directors have very distinct roles);
• members can agree amongst themselves how to share profits, management duties, how decisions are to be made, how new members are to be appointed and what retirement provisions shall apply;
• the Members’ Agreement (if there is one) is like a partnership agreement, i.e. a private document which need not be filed at Companies House; and
• although broadly, as stated above, the corporate insolvency regime also applies to LLPs, there exists an important disadvantage for members of an LLP compared to those of a company. LLPs are subject to the ‘clawback’ rule, which means that in certain circumstances money taken out of the LLP by members up to two years before commencement of a winding up of the LLP can be clawed back into the pool of assets available to repay LLP’s creditors (s.214A IA). By contrast, no equivalent provision applies if a shareholder disposes of shares in a company.

Taxation of LLPs

One important difference between an LLP and a company is that, for tax purposes, the LLP is treated as a partnership.

If two individuals set up an LLP, each will be taxed as an individual, i.e. liable to income tax or capital gains tax on their share of the income or gains of the LLP. In other words, an LLP is ‘transparent’ for tax purposes. This means the LLP is not taxed but the partners are.

By contrast, a company, established by the same two individuals, would pay corporation tax on its own income profit and chargeable gains. If the individual owners then receive dividends out of the company’s profits (after corporation tax), they may be liable to pay income tax on their dividend income. This could be significant, for example, because different rates and reliefs might apply.

A trade, profession or business carried on by an LLP with a view to profit will be treated as being carried on in partnership by the members (not the LLP itself). Many of the same reliefs available to partners also may be available to LLP members, such as relief on interest or set off of losses against other income.

Assets held by the LLP will be treated as being held by the members as partners for capital gains tax purposes. Accordingly, a disposal of an LLP asset, such as land, will be regarded by HMRC as a disposal by the members of the LLP while it is trading.

The LLPA gives relief from stamp duty where a partnership is incorporated as an LLP and assets of the partnership business are transferred to the LLP, subject to strict tax avoidance conditions. In some circumstances, stamp duty and/or SDLT is payable on the transfer of an interest in an LLP at the relevant rate.

As regards VAT, the LLP itself may register for VAT, not the members.

Commercial Uses for LLPs

Apart from being more and more commonly used for professional partnerships, such as solicitors, surveyors or accountants, it is also a flexible business vehicle for joint ventures, certain investment schemes and some venture capital
investments.

LLPs are particularly useful for investment structures (despite certain tax avoidance measures being applicable to LLPs which may impinge on private investors who are members of an LLP). This is because, as stated, LLPs are tax transparent, so they allow a high level of participation in management by the members whilst giving the members the benefit of limited liability. Furthermore, there is no need for a ‘general partner’’ with unlimited liability, in contrast to a limited partnership.

LLPs are increasingly being used by property developers involved in one-off joint venture development projects.

Introduction to Limited Partnerships

Limited Partnerships (LP) are formed and regulated in accordance with the Limited Partnerships Act 1907 (LPA) (although common law and the PA 1890 are still applicable to LPs). Essentially, an LP is an ordinary partnership but with certain modifications under the LPA.

The main difference between an ordinary (traditional) partnership and an LP is that some partners in an LP have limited liability for the debts and obligations of the partnership. Like partnerships (but unlike LLPs), LPs are not separate legal entities.

The PA 1890 applies to LPs except where inconsistent with the LPA. For example, if there is no agreement as to a profit sharing ratio, all partners share equally under s.24(1) PA 1890.

LPs require the involvement of at least two partners:

• at least one general partner; and
• at least one limited partner.

Nature of liability

A general partner’s liability is always unlimited. This reflects the fact that the general partner manages the business.

Limited partners have limited liability, up to the amount of their contribution to the LP (s.4(2) LPA). Importantly, however, this only applies if they are not involved in the day-to-day management of the partnership (s.6 LPA).

This makes LPs a useful vehicle for investment funds, where the general partner manages the fund and investors are protected from any liability by becoming only limited partners.

Roles of general and limited partners

The LPA does not describe what the general partners may do. Rather it focuses on what the limited partners cannot do. For example, the limited partners have no power to bind the firm. It is important that the management of the business is in the hands of the general partner(s) only. (Contrast the position of an ordinary partnership where management is in the hands of all the partners under s.24(5) PA 1890). If a limited partner takes part in the management of the partnership business he shall be liable for all debts and obligations during this period as if he were a general partner (s.6(1) LPA).

A general partner in a limited partnership is more akin to a managing director than to an ordinary partner on equal terms with the other partners.

The limited partners must agree before any changes are made to matters such as profit share, expulsion of partners, alteration in the nature of the partnership business and variation in the partnership agreement. These cannot be changed by the general partner alone.

Registration of LPs

LPs must be registered at Companies House under ss.5, 8 and 8A LPA. Limited partners in an LP that fails to be correctly registered forfeit their limited status and will be treated as partners in ordinary partnerships.

The information which needs to be filed (and updated when it changes) by an LP includes the firm’s name, the general nature of its business, the principal place of business, the names of the partners and the sum contributed by any limited partner (s.9 LPA). Under s.8B LPA all new limited partnerships must expressly include ‘Limited Partnership’ or ‘LP’ or the equivalent at the end of their names. The Registrar is required to issue a certificate of registration as conclusive evidence that the LP has been formed and registered (s.8C LPA). As with the Companies Register, the register of LPs is available for public inspection. LPs are registered with form LP5, which can be viewed on the www.gov.uk website.

Importantly, an LP need not file annual accounts or confirmation statements.

Dissolution of LPs

A limited or a general partner may dissolve the LP under a provision in the partnership agreement and the law relating to ordinary partnership dissolution will generally apply to LPs. One exception is that a limited partner may not dissolve the LP by notice if the LP is a partnership at will, without agreement from all the other partners (a general partner may however do so (s.6(5) LPA)).

Use of LPs

You may encounter LPs only rarely in practice unless you work with venture capital funds, private equity or real estate investment vehicles, which are often run through LPs.

In a venture capital partnership, investors (the limited partners) advance money, to be placed for them by the general partner (often referred to as a manager) in commercial ventures in need of finance. The manager will charge a fee and will receive a share of the profit. The LP vehicle is suitable as the majority of investors in a venture capital fund are passive investors and will not participate in the management of the fund.

LPs are the vehicle of choice for private equity fundraising. They are tax transparent and highly flexible: the partners can write their own internal partnership rules without having to conform to the detailed requirements of CA 2006.

In recent years, the limited partnership regimes in other jurisdictions have become more attractive to fund managers. The Treasury proposed a number of reforms to the UK regime to improve the UK’s competitiveness in this market. As a result, in April 2017 a new sub-type of LP, the Private Fund Limited Partnership (PFLP), was created (under the Legislative Reform (Private Fund Limited Partnerships) Order 2017) to reduce some of the administrative burdens on private investment funds which are structured as LPs.

Each partner is liable to tax as an individual on his share of the income or gains of the partnership. This is described as tax transparency.

Even though a partnership is not a distinct legal entity, HMRC requires a partnership to make a single tax return of its profits which must be agreed with HMRC (as with sole traders, partnerships choose their own accounting period). Partners submit their own individual tax returns containing all income received from the partnership as well as other income receipts (including, for example, from savings, dividend and/or rental income).

Each partner is personally liable for the tax on his share of the partnership profits. Unlike with other partnership liabilities where each partner is jointly and severally liable, a partner is not liable for the tax on other partners’ shares of partnership profits.

Normal capital gains tax principles apply on disposal of a capital asset by a partnership. Each partner is treated as owning a fractional share of the asset. On disposal by the partnership, each partner is treated as making a disposal of his fractional share and will be taxed on this fractional share of any gain, subject to the availability of any reliefs available to individuals. A partner’s fractional share shall be based upon the agreed PSR or, if there is no agreed PSR, then equally in accordance with s.24(1) PA 1890.

Partner leaving

If there is no partnership agreement or if the agreement is silent on retirement or termination (i.e. there is a ‘partnership at will’), the effect of a partner leaving is that the partnership is dissolved (see s.26 PA 1890). This is because ‘partnership’ is a collective noun meaning ‘all the partners’ and so the continuity of a partnership is broken when there is a change in the identity of the individuals who constitute it. In most cases this is a ‘technical dissolution’. This means that a new partnership is formed by the remaining partners who continue the business. However, it is open to any of the partners to apply to court to have the old partnership wound up (i.e. sale of the assets for the repayment of the partnership debts and for the distribution of the assets or liabilities amongst the partners).

To prevent dissolution when a partner leaves, the partnership agreement should state explicitly that the partnership will continue as between the remaining partners and should contain details of how a partner can leave (which may include a provision in the event of death) or be expelled without the partnership being wound up. This would usually include a mechanism for the remaining partners to buy out a departing partner’s share.

Dissolution of partnership

A partnership can be dissolved in a number of ways:

• automatic dissolution under s.32(a) and (b) PA 1890 (expiry of fixed term/completion of specific venture), s.33 PA 1890 (death or bankruptcy of partner) or s.34 PA 1890 (if the partnership business becomes unlawful). The provisions of ss.32 and 33 are subject to contrary agreement;
• dissolution of partnership at will (i.e. with no fixed duration) by notice from any partner (ss.26 and 32(c)); and
• dissolution by the court as a last resort under s.35 PA 1890.

If an event occurs which causes a partnership to be dissolved, the partnership relationship ceases and any partner may demand that the assets of the business are realised.

Winding up partnership: Collecting in/distributing assets (s.44 PA 1890)

Subject to any written partnership agreement, where a partnership is wound up, once all debts and liabilities have been paid, any money/assets left will be distributed so that each partner is paid back his/her original capital first (s.44(b)(3)). It is common for a partnership agreement to have a provision dealing with the proportion in which any surplus assets are to be shared out following dissolution. This is called the asset surplus ratio or ‘ASR’. If there is no agreed ASR then s.44(b)(4) applies and surplus assets are shared in accordance with the agreed profit sharing ratio PSR. If there is no PSR then they are shared equally in accordance with s.24(1) PA 1890.

Because a firm has no legal personality separate from the partners, the partners are personally bound under, and hence liable on, contracts which are binding on the firm. The PA 1890 contains provisions relating to the nature and extent of such liabilities. In some circumstances, non-partners can also become personally liable.

Nature of partners’ liability (ss.9, 10 and 12 PA 1890)

Contractual Liability: Every partner in a firm is liable jointly with the other partners for all the debts and obligations of the firm incurred whilst he is a partner (s.9).

Tortious Liability: In tort the partners’ liability is joint and several (ss.10 and 12).

Liability of non-partners: new and former partners (ss.17 and 36 PA 1890)

Under s.17(1) a new partner will not automatically be liable in relation to any debts incurred by the partnership before he joined.

Under s.17(2) a partner will still be liable after he retires in respect of debts incurred by the partnership whilst he was a partner. In order to relieve a partner from an existing liability once he retires, a partnership may novate the relevant agreement; this must be with the consent of the creditor (s.17(3)).

It is also possible for a former partner to become liable for new partnership debts incurred after he has left under s.36. If a partner leaves, a third party can treat all apparent partners of the firm as it was before the change (i.e. including the departing partner) as jointly liable to pay any new debt incurred by the partnership UNLESS that third party has been notified of this change either by:

• actual notice (s.36(1)) – for those who have had actual dealings with the partner before departure; or
• constructive notice by virtue of publication of the departure in the London Gazette (s.36(2)) – for those who have not had actual dealings with the partner before departure.

However, a former partner will not be liable for debts to any third party who did not know him to be a partner before he left. No notice at all has to be given to such persons.

Liability of non-partners: ‘holding out’ (s.14 PA 1890)

Generally, a person who is not a partner has no personal liability for partnership debts. However, s.14 sets out circumstances where a non-partner may be personally liable on a partnership debt if he has held himself out as a partner (or has knowingly allowed himself to be so held out).

The elements required for s.14 to have effect are (i) a representation to a third party to the effect that a person is a partner, (ii) the third party’s action in response (‘giving credit to the firm’, e.g. by supplying goods or services to the firm) and (iii) the third party’s state of mind (‘believing (having faith in) the representation’).

It is important to appreciate that s.14 relates to the liability incurred by the NON-PARTNER, not the liability of the firm. The liability of the firm for the acts of a non-partner is established by applying the common law principles of agency.

In practice, you may need to decide whether or not the partnership is bound by a contract which an individual has purported to make on its behalf. In a partnership context, the approach to answering the question of whether or not a firm is bound by a particular contract will differ depending on whether the individual acting on the firm’s behalf is a partner or not. This is because s.5 PA 1890 introduces a special statutory rule of agency which applies only when the agent in question is a partner in the firm. Where the purported agent is not a partner, you apply rules from the common law. We will consider each of the ‘partner’ and ‘non-partner’ approaches separately below.

Partners content with agent’s act (whether partner or non-partner)

In many cases, an individual acting as a firm’s agent (whether a partner or not) will simply have put into effect the wishes of the partnership as a whole. If all the partners are happy for the firm to enter into the contract and have given actual, express or implied authority to bind the firm, then the firm will be bound. In any event, if the partners are happy to be bound, the situation is not problematic even if the agent had no authority at the time the contract was made. The partners are able to ratify the agent’s act and adopt the contract, either expressly or simply by going ahead and performing it.

Partners not content with agent’s act

Either s.5 PA 1890 or the common law rules of agency will determine whether or not the firm is bound, depending upon whether the agent is a partner or not.

Power of a partner to bind the firm against the partners’ wishes: s.5 PA 1890

Section 5 makes provision for the firm to be bound in certain circumstances, even where the other partners are not happy to be bound by the contract made by the agent. Since s.5 is intended to protect the third party to the contract, it is that third party’s view of what is happening that counts.

Following s.5, a partner’s unauthorised act will bind the firm if, viewed objectively:

• the act is for carrying on business of the kind carried on by the firm (for example, “is this the kind of contract that one would expect to be done in the course of business of this kind?”); and
• the act is for carrying on such a business in the usual way (for example, “is this the kind of contract that a partner acting alone would usually make on the firm’s behalf or is it a contract of the kind an outsider would expect all partners in a firm to sign individually?”).

The firm will not be bound, however, if:

• the third party actually knew that the partner in question was not authorised to enter into the contract on behalf of the firm; or
• the third party did not know or believe that the partner was a partner.

A partner who binds his firm without actual authority may be liable to the other partners for breach of contract.

Power of a non-partner to bind the firm against the partners’ wishes: apparent authority at common law

Section 5 does not apply at all if the person entering the contract is not in fact a partner. In that case, the common law rules of agency establish whether or not the firm is bound as principal.

At common law, an agent who has no actual authority may still bind the firm if he has apparent authority to enter into a contract. Apparent (sometimes called ‘ostensible’) authority arises when the principal (here the firm) represents or permits a representation to be made to a third party that a person has authority to bind the firm. For example, if a firm employs somebody under the title ‘marketing manager’, that title confers on that person apparent authority to bind the firm on marketing decisions. Once the principal’s representation has been made to, and relied upon by, the third party, the principal is bound by the actions of that person.

If the representation is that a particular person is a partner (when, in fact, they are not), then the firm is said to be ‘holding out’ that person as a partner. A person who has been held out as a partner has apparent authority to bind the firm in the same way as a real partner can. An example of holding out is in relation to an ex-partner, when the firm carries on using old letterhead (including his or her name) after he or she retires.

Section 5 is always the first place to look when deciding whether or not an act of a partner binds a firm but does not displace the application of ordinary common law agency entirely. In some circumstances, s.5 alone will not get you to the end of the story. If a partner has purported to form a very unusual kind of contract on behalf of the firm, a s.5 analysis may lead you to conclude that the firm is not bound under statute. However, the particular facts and circumstances of the case may mean that this partner did have his partners’ apparent authority at common law to conclude the contract.