LPC

Termination of a partnership

TheLawStudent

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.

Personal liability for partnership debts

TheLawStudent

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.

The relationship between the firm and outsiders: contracts binding the firm

TheLawStudent

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.

General partnerships

TheLawStudent

In practice, you will sometimes find that clients ask for your help to avoid creating a partnership, rather than asking you to create one for them. One reason for this is that the legislation governing partnerships is over 100 years old and the default provisions, which will be implied by that legislation, are often unsuited to the modern business environment. Additionally, clients may have concerns about being subject to unlimited liability.

Nevertheless, there are some advantages. For example, it costs nothing to create a partnership, because no formality is required to create one. In fact, there are almost as many partnerships in the UK as there are companies and many of them are professional partnerships such as lawyers, accountants, surveyors and architects. Many businesses start as partnerships before they convert to a limited company.

The Partnership Act 1890 (PA 1890)

The PA 1890 provides the framework for regulating traditional partnerships. However, there is case law to supplement the PA 1890, and I will cover a small number of cases in later posts.

Whilst the PA 1890 and case law provide a framework for governing traditional partnerships, they are really ‘fall-back’ provisions in the absence of a partnership agreement or where the agreement is silent on any matter. Most traditional partnerships will have a formal written partnership agreement.

Existence of partnerships

As mentioned previously, a partnership is a relationship between persons carrying on a business in common with a view of profit (s.1(1) PA 1890).

Section 2 PA 1890 contains a list of rules for determining the existence of a partnership. The purpose of s.2 is to provide more detailed guidance in determining if the criteria in s.1(1) have been met. For example, evidence of profit sharing will be prima facie evidence of a partnership but not necessarily conclusive evidence (s.2(3) PA 1890). Case law provides that if there is an agreement to share losses as well as profits this makes the existence of a partnership more likely (Northern Sales (1963) Limited v Ministry of National Revenue (1973)). A loan of money by one party to another does not create a partnership.

Case law has also held that if the person is not being “held out” as a partner this makes the existence of a partnership less likely. In Walker v Hirsch (1884) a clerk lent money to the partnership, was paid a fixed salary and took 1/8th of the profits and of the losses but was never held out as a partner. No partnership was found to exist.

Partnerships, Limited Partnerships & Limited Liability Partnerships

TheLawStudent

Introduction to partnerships

I briefly touched on the different types of businesses entites in my posts about business taxation, where we looked at sole traders, partnerships and limited companies. Over the next series of posts, we will look in depth at the different types of partnerships that exist.

We will consider three different types of partnerships:

  • The traditional partnership, which is governed by the Partnership Act 1890, which contains the basic structure of partnership law. this type of partnership is often known as a ‘general partnership’. The partners in a partnership of this type have unlimited liability for the debts and obligations of the partnership.
  • The Limited Partnership (LP), which was introduced by the Limited Partnership Act 1907. Provided one partner is the general partner and therefore accepts unlimited liability, all of the other partners (known as the limited partners) can benefit from limited liability. The limited partners must not be involved in the day-to-day running of the partnership business (otherwise they lose their limited liability status). For this reason, LPs are often used in fund structures. The limited partners are passive investors with no active role in managing the partnership business.
  • The Limited Liability Partnership (LLP), which was introduced by the Limited Liability Partnerships Act 2000. LLPs are often described as hybrids as they combine elements of both a partnership and a company. They have the flexibility of conventional partnerships in relation to their internal arrangements but they are treated as single legal entities with limited liability of their own. LLPs are subject to many provisions of the Companies Acts (and most particularly the Companies Act 2006).

Business Strategy

TheLawStudent

Over the past couple of posts, I have looked at different types of business analysis. Of course, analysis is only part of the picture of business management, there is also a strategic process. Strategy goes on at all levels of an organisation all the time. As the diagram below shows, strategies can exist at corporate, business or functional levels.

Most large businesses have a clearly verbalised mission which rarely changes and any strategic work that they do on a day-to-day basis will be focused on achieving this mission. Therefore, modern businesses are very aware of strategic alignment. This simply means that any strategic activity which takes place which is not at the level of changing the overall strategy or mission of the business needs to align with the bigger picture which already exists.

Businesses often suffer the basic structural dilemma of how much autonomy to allow lower order units in implementing the overall strategy. For example, the question of how much independence the main board gives subsidiary boards in implementing their strategies.

Organisations can either deal with this dilemma by centralising the decision making processes or decentralising it so that the managers at each business unit make the decisions. This will be a significant consideration for you when dealing with clients that are business units or larger organisations as to identifying who the actual decision makers are.

The more clear employees and customers are on what a business stands for and how things are ‘done around here’, the quicker the business can react to changes because there is a better instinctive understanding of what to do. This is really important in large businesses, because it is not possible to seek consensus on every decision from every level of the organisation. As long as senior management has made it clear what the business’ overall strategy is and how this works in practice, employees can be fairly comfortable, when making decisions that affect the organisation that they are acting in a way which reflects, rather than conflicts with, this overall strategy.

Legal professionals involvement in businesses

Much of the advice that businesses seek from legal firms will be as result of strategic change or activity. Often, managers will require legal advice in connection with the implementation of their plans. Some examples of such situations may be:

  • managers may need advice about new contracts with suppliers, staff or customers;
  • businesses may want help with acquiring property, other businesses or entering into a joint venture;
  • a referral to the Competition and Markets Authority;
  • a recession may have led to the need to make staff redundant;
  • setting up a new business vehicle to enter into a new marketplace; and
  • understanding the legislation to set up a new division of the business overseas.

For all of these reasons, and many more, lawyers are an essential part of the business process, particularly where strategic activity is involved. As such, having a good understanding of this area will ensure that you are able to provide appropriate, considered, timely and cost efficient advice.

Environmental scanning

TheLawStudent

Whilst a SWOT analysis is a good initial tool for understanding what lies just outside the business in terms of opportunities and threats, it is very important for a business to have a very good understanding of the external environment as it is filled with opportunities and risks. This is often referred to as ‘Environmental Scanning’.

Therefore, in conjunction with a SWOT analysis, businesses will also undertake a detailed environmental scan to identify what would be considered as ‘threats’ in the SWOT analysis. To do this, they will often use a further framework. Increasingly, the frameworks which are used are sophisticated, complicated and involve weighting a number of factors which have been identified as critical to future business success.

However, there is a simple model which can help to undertake environmental scanning regardless of business or sector, which is PESTLE. This is another acronym, which stands for ‘Political, Economic, Socio-cultural, Technological, Legal and Environmental’, representing six types of environmental factors which need to be taken into account. Here Apple Inc. will be used as an example.

Political

A business will scan the political environment, looking for opportunities and threats brought about by government intervention or wider political influences. For example, Apple would be concerned about the Competition and Markets Authority intervening in its business due to its growing dominance in the handheld computer market. The political stability of a nation such as China, which is heavily involved in the production (and, increasingly, consumption) of computing goods, would also be of interest to Apple. Alternatively, a change in the political landscape may bring opportunities to Microsoft, too, such as a more liberal market approach from a government which is less concerned with monopolistic markets.

Economic

A business will also be interested in the economic environment, for example the cost of borrowing, the availability of borrowing, exchange rate movements, inflation and whether a country is in a period of growth or recession. Apple would see a threat in any weakening of the dollar relative to the Euro. Apple is based in the US and so a weakening of the dollar would increase the cost of production abroad and reduce the profits made in sales abroad.

Socio-cultural

Social factors commonly encompass demographic issues and lifestyle changes. For example, Apple may see the growth of the affluent middle classes in India as a real opportunity to increase sales in this market.

Similarly, lifestyle changes will have an impact. Factors such as a greater concern for the natural environment, an increase in Higher Education and the rise of social networking have all created new opportunities and threats for businesses in various ways. For Apple, the growth in social networking has created real opportunities but the interest in the natural environment has meant that it has received some considerable negative publicity over the mining and use of rare metals in its electronic devices.

Legal

This encompasses statutory provisions and the common law in relation to relevant areas of law including company, employment, commercial, environmental protection, intellectual property and data protection. This will also include regulatory provisions governing such matters as competition, corporate governance, advertising and trading standards. You can see here how there is some considerable overlap with Political and Economic factors. An example of a legal factor impacting Apple is the complex international litigation with Samsung for various intellectual property patent infringements.

Environmental impact

There has been a rapid growth in pressure on businesses to be environmentally friendly. This has impacted on what businesses do and how they operate with many being called to account for negative impacts on the environment. As Apple works in a sector which has a heavy impact on natural resources, it needs to recognise the potential threats of depletion of these resources as well as negative publicity for such depletion. However, opportunities exist for Apple to establish itself as a green manufacturer if this is an avenue it chooses to exploit.

Criticisms of PESTLE

PESTLE analysis is often criticised for being too simplistic, for not weighing different factors to take into account the relative opportunities and threats which they present and for not being sensitive to the differences in sectors. However, it is useful just because it is a simple tool and it can be applied across businesses. You may find, however, that you are encouraged to use more complex or different tools in later strategic work.

Types of market

TheLawStudent

When you are trying to understand the status quo of a business, a key factor is the nature of the market in which it operates, in particular, you will be interested in the number of competitors and therefore the level of competition it can expect.

Some common classifications are set out below.

Monopoly

A market form in which there is only one business undertaking, meaning that there are no competitors. Within the UK, the Competition and Markets Authority tries to guard against abuses of monopolies.

Oligopoly

A market in which there are only a few (perhaps three of four) major competitors, which control the vast majority of the market. The small number of sellers makes it easier for any particular business to be more aware of what the other players in the market are doing. Price fixing is often seen in this type of market. This is where key players collude to set prices. They can set prices high, because there is nowhere else where consumers can then go to get a lower price. Alternatively, perhaps two providers will collude together to set prices low in order to push out other players and then raise their prices to recoup their losses. This is known as predatory pricing.

Monopolistic Competition

In this scenario, there are many competing businesses and consumers in the market and, because products are differentiated between businesses, there is more than just a price consideration between products. In the short run, firms may have a monopoly on their products but in the longer run, because there are usually low barriers to entry, other providers may step in to their market.

Oligopsony

This is quite a specific type of market form but one which you are likely to come across if you work within the farming sector, where there are many suppliers, such as cocoa, tobacco or cattle farmers but they have only a few possible buyers to which that they can sell. In the case of cocoa, there are only three major buyers which sell the cocoa beans on to chocolate makers.

When you are trying to understand a business, it is very useful to understand the market form that it operates within as it will provide you with an idea of how competitive its sector is and therefore what conditions it operates within.

SWOT analysis

TheLawStudent

Another way of examining a business’ ‘status quo’ is to look at its internal and external risks and opportunities as they currently stand. A classic yet simple way of doing this is through a SWOT (Strengths, Weaknesses, Opportunities and Threats) analysis, which provides a systematic way of doing so.

As an example of the SWOT analysis approach, we will consider Walmart, the multinational supermarket chain.

Strengths

A business’ strengths are those factors which make it somehow ‘better’ or potentially better than the competition. These may also be labelled ‘competitive advantages‘. Walmart’s strengths include:

  • exceptional buying power, due to its size relative to the competition;
  • considered to be a very good employer, helping with recruitment and retention of top quality staff; and
  • strong reputation based on a wide range of products at affordable prices.

Weaknesses

A business’ weaknesses are those factors which somehow place the business at a disadvantage relative to other companies operating in the same market. Walmart’s weaknesses include:

  • it may be a global company but its business is focused in particular countries, such as the UK and US, meaning that it does not have market domination in many of the rapidly growing countries such as China and India;
  • it has a very bad reputation for corporate social responsibility, despite considerable efforts in this field. Documentaries such as ‘Walmart: The High Cost of Low Price’ mean that it is seen as an unethical trader, reducing its brand value; and
  • it is so big that it may be difficult to react quickly to rapid changes in the market, leaving it exposed.

Opportunities

Opportunities exist external to the business and are chances to increase sales or profits within the wider environment. Walmart’s opportunities include:

  • mergers or acquisitions with companies in areas such as China or India to increase market share quickly; and
  • the trend for smaller, local branches of supermarkets in the US and UK is something which Walmart has not yet exploited but where there is a potential for money to be made.

Threats

Threats also exist external to the business and are things which could cause problems. These may also be labelled as ‘competitive disadvantages’. For Walmart, these include:

  • continuing bad reputation for corporate social responsibility means that Walmart needs to be very careful not to expose itself to bad publicity with regard to this;
  • intense price competition between Walmart and other supermarkets or suppliers could reduce Walmart’s profit margins significantly; and
  • the growing costs of food which are being experienced across the world may also reduce Walmart’s profit margins.

Once a business has undertaken a SWOT analysis, those involved will have a much better idea of its current status. This analysis will feed into the process of creating strategic options, allowing the business to capitalise on opportunities and competitive advantages and mitigate where possible the weaknesses and threats.

The Business Life Cycle

TheLawStudent

Every business is likely to go through a whole life cycle, from set-up to shutdown. Understanding what stage a business is at in this life cycle will help you to know what their opportunities and challenges may be.

Stages in the business life cycle

Incorporation

All new business ventures start with an idea. An entrepreneur might have an idea about starting a brand new business in order to launch a new product or service. Examples of this would be James Dyson’s idea of a new type of vacuum cleaner or the launch of Facebook by Harvard students. Alternatively, an idea may come from a pre-existing business that wants to head in a new direction, bringing something fresh to the market. Whenever a business begins its life the people with the ideas for that business must decide which business medium to use i.e. sole trader, partnership, limited liability partnership or company. If it is decided that the new business should be operated through a company then the first stage will be to incorporate that company.

Raising Money

If a business chooses to incorporate, it can begin to trade as a company once it has been incorporated. Early in the growth cycle the business will need to raise money to begin its life because it will need to buy the resources needed in order to start to sell its products or services. For some businesses, set-up costs will be low, for example setting up a recruitment consultancy requires very little to get started. For others, for example beginning a brand new chain of restaurants, there will be very high set-up costs associated with recruiting staff, fitting out restaurants and marketing the restaurants to ensure that people come to eat there.

There are two main ways in which a company can raise money, firstly through the issue of shares known as equity finance. This is where the company issues shares in exchange for cash. The shareholders will therefore own a stake in the company and will expect to receive dividends (income) on their shares and a capital return (i.e. a gain over and above what they originally paid for the shares) if and when they sell their shares. Shares could be offered publicly, to friends or colleagues, or even sold to venture capitalists such as 3i. Venture capitalists tend to invest in high-risk start-ups which they believe will offer a high return on investment if they are successful.

The second way a company can raise capital is through debt finance. This is where a company borrows money and in return promises to repay that loan plus interest. A lender, such as a bank, will usually insist on taking some form of security over assets from the company which, through security enforcement processes, will help it to receive back as much of its money as possible if the company defaults on the loan payment or if the company breaches the loan agreement.

Expansion

Successful businesses often want to grow. A business can do this organically, by increasing sales and profit through natural growth of its own business. Expanding the range of products or services or widening the target market can both be effective strategies for natural or organic growth.

A business can also grow acquisitively. If the company buys a competitor, perhaps to gain its customer list and therefore its market share, this is known as horizontal integration. In the 2000s, there were a significant number of horizontal integrations in the pharmaceutical sector, for example between Glaxo Wellcome Plc. and Smithkline Beecham Plc., which subsequently became GlaxoSmithKline Plc. Alternatively the successful business might acquire a business which is part of its supply chain; either a supplier or a distributor. This process can be referred to as vertical integration, an example of which is the takeover by the wholesaler Booker of Budgens and Londis grocery chains.

Insolvency

Finally, if things do not go to plan, the last stage in a company’s life cycle may be insolvency. This is where an insolvency process is commenced in circumstances where the company is not able to pay its debts. Over the past few years there have been a number of high profile insolvencies in the travel and retail sectors, such as Thomas Cook in September 2019, Debenhams, which went into administration in April 2020 and Arcadia Group (owners of brands such as Topshop, Dorothy Perkins, Burton and Miss Selfridge) in November 2020.

Why does this matter to a lawyer?

If you can understand where in the business life cycle the business you are working with is positioned, you will have a better understanding of the types of opportunities and threats they are facing. For example, a company that is teetering on the brink of insolvency will have a very different range of concerns to one which has just been offered a £10 million equity investment by a venture capitalist to develop a new business idea.