You’d like to better understand partnership agreements!
You are wondering what is the difference between a general partnership and a limited partnership?
What are the advantages of each type of partnership?
These are great questions!
We’ve got answers…
In this article, we will go over the specifics of partnership agreements. We’ll discuss the different types of partnerships, what is a partnership agreement, what is contained in a contract of partnership, the characteristics of a general and a limited partnership and more.
We have divided this article into the following sections for your ease of navigation:
- What are the different types of partnerships?
- What are partnership agreements?
- What is in a contract of partnership?
- What are the advantages of partnerships
- Characteristics of a general partnership
- Characteristics of a limited partnerships
- Partnership examples
- Important clauses every partnership contract should have
- How is the partnership liability different than each partner’s liability?
- Operating agreement for limited partnerships
Let’s get started.
What are the different types of partnerships?
There are essentially three types of partnerships:
- General partnerships
- Limited partnerships
- Undeclared partnerships
A general partnership and a limited partnership are necessarily established with a partnership agreement whereas an undeclared partnership in most cases will result based on a verbal agreement of the partners.
With respect to an undeclared partnership, the partners through their actions and behaviour clearly show the intention of the partners to form a partnership.
The general partnership and limited partnership is formed under the name that is common to the partners.
It is generally better to ensure you have a partnership agreement in place instead of falling into an undeclared partnership.
Undeclared partnerships are formed implicitly or based on a verbal contract.
However, without a partnership agreement clearly calling out the rights and obligations of the partners, an undeclared partnership can quickly lead to disputes and misunderstandings.
Having a partnership agreement in place will allow you to clearly define each partner’s roles and responsibilities, avoid any tax issues, avoid legal and liability issues, have a clear structure to handle new partners and how partners can leave the partnership and ensure you have a frame of reference in the event of a dispute.
What Are partnership agreements?
A partnership agreement is an agreement entered into by two or more people or entities setting out the rules of how to conduct business between them.
A partnership agreement will cover the essential rules governing the partnership such as who are the partners, what is the objective and mission of the partnership, how much capital each partner will contribute, the roles and responsibilities of each partner and so on.
A partnership agreement will be signed by all the partners and will define each of the partners’ rights and obligations.
The partnership agreement should be prepared when you start the partnership.
What is in a contract of partnership?
A contract of partnership is a contract by which the partners, in the spirit of cooperation, agree to carry on a business activity by combining their knowledge and property and ultimately sharing the economic benefits.
Typically, a contract of partnership will have specific clauses relating to the business contemplated by the partners and also important legal clauses.
In essence, you will see the following clauses in a contract of partnership:
- The nature of the business to be run by the partnership
- The term of the partnership agreement
- The name of the partnership
- The place of business of the partnership
- How new partners may be admitted
- How partners may leave the partnership
- Non-competition and non-solicitation clauses
- Capital contribution required by the partners
- How the profits and losses will be attributed
- How partners may draw from the partnership
- When the financial statements are to be prepared
- The partnership’s payment obligations
- The management of the partnership
- How the management meetings will be handled
- The banking operations of the partnership
- Mechanism to dissolve the partnership
- How to manage the death of a partner
- Governing law
We’ve outlined the expected clauses found in a partnership agreement but depending on the nature of your partnership, you may add more specific provisions.
What are the advantages of partnerships
Partnerships provide some advantages to the partners uniting forces.
Setting up a partnership is not as costly as an incorporated company and can be easier to operate in some cases.
Partnerships do not have a separate income tax to file the same way as an incorporated company.
Depending on the partners’ personal income, they may benefit from tax advantages available to individuals that they would not otherwise have the ability to get.
By the same token, the partners can use their business expenses to reduce their overall tax burden.
However, if the partnership is an incorporated entity, then it will be a distinct legal person.
With a partnership, considering there are partners uniting knowledge, property and capital for a common purpose, partnerships will have an easier ability to get funding and raise capital than each individual partner.
Characteristics of a general partnership
A partner is obligated to the partnership for everything he or she promises to contribute to the partnership.
A partner can contribute property to the partnership by placing the property at the disposal of the partnership.
When a partner undertakes to contribute to the partnership with knowledge or in helping the partnership’s activities, such obligations will be continuous for so long as the partner is a member of the partnership.
Any clause in the partnership agreement excluding the partner’s right to share in the profits of the partnership is invalid.
A partner is entitled to recover any disbursements he made on behalf of the partnership and be indemnified by the partnership for any losses he suffered in acting for the partnership.
A partner may bind the partnership in the course of its business activities.
The other partners have the right to restrict the right of a partner to bind the partnership or oppose to dealings of the partnership.
Characteristics of a limited partnerships
A limited partnership consists of one or more general partners who are authorized to manage and bind the partnership and one or more special partners who contribute to the common stock of the partnership.
With a limited partnership, you can issue securities to increase your common stock.
Any person buying into the common stock of the limited partnership will become a special partner.
The general partners in a limited partnership must administer the partnership and are accountable to the special partners in the same way as an administrator of an incorporated company.
Each special partner is entitled to receive his or her share of the profits of the partnership.
The special partners can also receive their share of the profits to the extent the partnership has enough property to discharge the debts of the partnership.
The special partner is not authorized to negotiate any business on behalf of the partnership or act as an agent of the partnership.
There are some great examples of partnerships that worked quite well.
We’ve outlined some of the famous co-branding partnership examples:
- GoPro and Red Bull
- Casper and West Elm
- BMW and Louis Vuitton
- Starbucks and Spotify
- Uber and Shopify
- Nike and Apple
- Bonne Belle and Dr. Pepper
There are many more but partnerships can exist in small scale or between large organizations as such.
Important clauses every partnership contract should have
There are a few types of clauses every partnership contract must have.
These clauses are:
- Capital contribution
- Duties as partners
- Sharing and assignment of profits and losses
- Acceptance of liabilities
- Dispute resolution
Your partnership contract should specifically outline the nature of the contribution of each partner along with the percentage of each partner’s interest in the partnership.
In addition, the partnership contract should take good care in defining the responsibilities of each partner such as each partner’s level of authority, ability to bind the partnership, management duties and other.
It’s also important to ensure the partnership contract clearly spells out how profits and losses will be shared between the partners.
Depending on the extent of profits and losses, the partnership contract should state if the partners are authorized to draw funds from the capital of the partnership, under what conditions and when.
The personal liability of each partner should be spelled out and in what circumstances they can be held personally liable.
It should be clear in what instances a partner can personally be held responsible should the partnership become indebted and unable to meet its debts.
Finally, in the event of a dispute, a proper dispute resolution mechanism should be mutually agreed upon.
How should partners handle disagreements or disputes, should partners go to court or arbitration.
With a good dispute mechanism provision, the partners can limit the possibility of unnecessary exposure of the inner workings of their partnership and provide for ways in internally handling conflict.
How is the partnership liability different than each partner’s liability?
Depending on the type of partnership you have structured, the partnership liability and that of its partners will be handled in a different way.
Let’s look at the highlight of the partnership liability for general partnerships and limited partnerships.
Partners in a general partnership will share the profits along with the losses in the proportion outlined in their partnership agreement.
If the partner’s shares in the partnership agreement are specifically outlined, that will dictate the extent of the partner’s participation in the profits and losses.
In the absence of any specific mention of a partner’s share in the partnership, by default each partners will be deemed to have an equal share in the partnership.
Any stipulation in the partnership agreement that a partner is exempt from any obligations to share in the losses may not be set up against third parties dealing with the partnership.
Where the property of the partnership is not sufficient to cover its debts, the general partners are solidarily liable to third parties for the debts of the partnership.
Special partners will be liable for the debts up to the agreed amount of the special partner’s contribution.
Any contractual stipulation where a special partner is to act as a guarantor of the partnership or assume the debts of the partnership beyond the amount agreed upon is without legal effect.
A special partner who’s name appears on the firm name will be liable for the debts of the partnership in the same manner as a general partner unless his quality of a special partner is clearly defined.
Under a limited partnership set up, a special partner may not claim amounts from the partnership as a creditor until all other creditors of the partnership are satisfied.
Operating agreement for limited partnerships
An operating agreement is an important document outlining the rights, powers, duties, liabilities and obligations of the members of a limited partnership under a common-law jurisdiction.
Operating agreements are also called membership agreement.
In the Province of Quebec, we refer to this as the partnership agreement.
An operating agreement will contain clauses such as:
- Term of the partnership
- Purpose of the partnership
- Members, contributions and interests of each partner
- Management of the partnership
- Entering and exiting of partners
- Liability clauses
- Non-compete clause
- Conflict of interest policy
- Confidentiality clause
In Quebec, a partnership agreement or a partnership contract will cover similar provisions as that of an operating agreement.
There you have it.
We have covered the essentials to understand partnership agreements.
A partnership agreement is the contract you will sign defining your rights and obligations as a partner in a partnership.
Depending on the nature of the partnership you are setting up, general partnership or limited partnership, the partnership agreement should clarify the rights and obligations of each partner.
We hope you liked this article.
Should you need support in drafting, negotiating or understanding partnership agreements, don’t hesitate to reach out to our business lawyers who will be happy to support you.
Our business law firm is well-positioned to provide legal support and assistance to anyone looking to set up a partnership agreement.