Imagine you and a friend decide to start a business together. You both put in money and effort, and you share the profits and losses. That is a partnership. But not everyone in a partnership is the same. Some are more involved than others.
Definition of Partnership
A partnership is a legal relationship formed when two or more individuals agree to carry on a business together with the intention of sharing profits. It is a way for people to pool resources, skills, and knowledge to achieve a common business goal.
The core of a partnership is the agreement between the partners. This agreement can be formal, like a written contract, or informal, like a verbal understanding. The key is that there is a mutual agreement to work together and share the outcomes.
Types of Partners
1. General Partner:
A general partner is actively involved in the day-to-day management of the partnership. They have unlimited liability for the partnership's debts and obligations.
This means that if the partnership owes money, the general partner's personal assets can be used to pay those debts. They are the ones who are making the everyday decisions. They have the most responsibility.
2. Limited Partner:
A limited partner is an investor who contributes capital to the partnership but is not actively involved in management. Their liability is limited to the amount of their investment.
This means that their personal assets are protected. They only risk losing the money they invested. They are generally only investors. They are not making management decisions.
3. Active Partner:
An active partner is involved in the day-to-day operations and management of the partnership. This term is often used interchangeably with general partner.
This term is used to emphasize the partners involvement in the business.
4. Silent Partner:
A silent partner contributes capital to the partnership but is not actively involved in management and their involvement is not publicly known.
These partners are often investors who want to remain in the background.
5. Nominal Partner (Partner by Estoppel):
A nominal partner is not actually a partner but allows their name to be used to represent the partnership, leading others to believe they are a partner. They may be held liable for the partnership's debts.
This type of partner is not a real partner. They are only held liable because they allowed their name to be used.
6. Partner in Profits Only:
This type of partner shares in the profits of the business, but does not share in the losses, nor are they involved in the management of the business.
This is a limited form of partnership.
7. Managing Partner:
This is a general partner who is assigned specific duties to manage the partnership.
This partner has extra duties, and responsibilities.
Duties of Partners:
When you are in a partnership, you have certain responsibilities to your partners. You need to be honest, fair, and work together for the good of the business.
Duties of Partners:
1. Duty of Good Faith and Fair Dealing:
Partners must act honestly and in good faith towards each other. This means they should avoid any actions that could harm the partnership or their fellow partners.
This duty is the cornerstone of any partnership. It requires partners to be transparent, truthful, and to act in the best interests of the business, rather than pursuing personal gain at the expense of the partnership.
2. Duty of Loyalty:
Partners must prioritize the interests of the partnership over their own personal interests. They must avoid conflicts of interest and refrain from competing with the partnership.
This duty means that partners should not engage in activities that could undermine the partnership's success. For example, they should not secretly divert business opportunities to themselves or engage in a competing business without the consent of their partners.
3. Duty of Care:
Partners must exercise reasonable care and diligence in managing the partnership's affairs. They must act prudently and avoid negligence.
This means that partners should make informed decisions, keep accurate records, and take reasonable steps to protect the partnership's assets. They should act as a reasonably prudent person would in similar circumstances.
4. Duty of Accounting:
Partners must keep accurate and complete records of all partnership transactions and provide full access to these records to their fellow partners.
This duty ensures transparency and accountability within the partnership. Partners should be able to review the partnership's financial records and understand how the business is being managed.
5. Duty of Disclosure:
Partners must disclose to their fellow partners all relevant information that could affect the partnership's interests.
This includes disclosing any conflicts of interest, potential liabilities, or other material facts that could impact the partnership's operations or financial performance.
6. Duty to Contribute Capital and Share Losses:
Partners are generally obligated to contribute capital to the partnership as agreed upon in the partnership agreement. They are also responsible for sharing in the partnership's losses according to the agreed-upon ratio.
This ensures that all partners are invested in the success of the business.
7. Duty to Participate in Management:
Unless otherwise agreed, partners have the right and responsibility to participate in the management of the partnership.
This ensures that all partners have a voice in how the business is run.
8. Duty to Observe the Partnership Agreement:
Partners are bound by the terms of the partnership agreement and must adhere to its provisions.
This is the document that outlines the rules for the partnership.
Partnership vs. Company:
Think of a partnership as a close-knit team where everyone is directly involved and responsible. A company is more like a structured organization with clear roles and limited personal responsibility.
Partnership vs. Company: Detailed Comparison
1. Legal Structure:
Partnership: A partnership is typically a less formal arrangement, governed by a partnership agreement. It is not a separate legal entity from its owners.
This means that the partnership itself does not have a separate legal existence. The partners are the business.
Company: A company (corporation) is a separate legal entity, distinct from its shareholders. It is governed by its articles of incorporation and bylaws.
This separate legal entity is very important, because it allows the company to enter contracts, sue, and be sued, in its own name.
2. Liability:
Partnership: General partners have unlimited personal liability for the partnership's debts and obligations.
This is a major disadvantage of partnerships.
Company: Shareholders have limited liability, meaning their personal assets are generally protected from the company's debts.
This limited liability is a major advantage of companies.
3. Management:
Partnership: Partners are typically actively involved in the management of the partnership.
Management is often shared between all the partners.
Company: Management is typically delegated to a board of directors and officers, who are elected or appointed by the shareholders.
This allows for a more structured and professional management style.
4. Taxation:
Partnership: Partnerships are typically "pass-through" entities, meaning profits and losses are passed through to the partners' individual tax returns.
This avoids double taxation.
Company: Companies are subject to corporate income tax, and shareholders may also be taxed on dividends (double taxation).
This double taxation is a major disadvantage of companies.
5. Formation:
Partnership: Partnerships are relatively easy and inexpensive to form.
This ease of formation is a major advantage of partnerships.
Company: Companies require more formal procedures and are generally more expensive to form.
This is a disadvantage of companies.
6. Ownership Transfer:
Partnership: Transferring ownership in a partnership can be complex and may require the consent of all partners.
This can cause issues when partners wish to leave the partnership.
Company: Ownership in a company can be easily transferred through the sale of shares.
This ease of transfer is a major advantage of companies.
7. Continuity:
Partnership: Partnerships can dissolve upon the death, withdrawal, or bankruptcy of a partner.
This lack of continuity is a major disadvantage of partnerships.
Company: Companies have perpetual existence, meaning they continue to exist even if shareholders or director’s change.
This continuity is a major advantage of companies.
8. Raising Capital:
Partnership: Partnerships may find it more difficult to raise capital compared to companies.
They are limited to the funds of the partners, and loans.
Company: Companies can raise capital by issuing shares or bonds.
This ability to raise capital is a major advantage of companies.
Termination of Partnership:
A partnership does not last forever. It can end when the partners agree, when the agreed time is up, or when something unexpected happens, like a partner dying.
Methods of Termination: Detailed Explanation
1. Agreement of Partners:
Partners can mutually agree to dissolve the partnership at any time. This can be done through a written agreement or a verbal understanding.
This is the most straightforward method. If all partners concur that the business should cease operations, they can formally agree to terminate the partnership.
2. Expiry of Term:
If the partnership agreement specifies a fixed term or duration, the partnership automatically terminates upon the expiration of that term.
For instance, if the partnership was formed for a period of five years, it will dissolve at the end of that five-year period, unless the partners agree to extend it.
3. Completion of Undertaking:
If the partnership was formed for a specific project or undertaking, it terminates upon the completion of that project or undertaking.
For example, if a partnership was formed to build a specific building, it will terminate upon the completion of the building.
4. Death of a Partner:
In most jurisdictions, the death of a partner automatically dissolves the partnership, unless the partnership agreement provides otherwise.
The partnership agreement can contain clauses that allow the partnership to continue even if a partner dies, but if there is no clause, the partnership will terminate.
5. Bankruptcy of a Partner or the Partnership:
The bankruptcy of a partner or the partnership itself can lead to the dissolution of the partnership.
Bankruptcy proceedings can disrupt the partnership's operations and make it impossible for the business to continue.
6. Court Order:
A court may order the dissolution of a partnership under certain circumstances, such as:
When a partner is permanently incapable of performing their duties.
When a partner's conduct is prejudicial to the partnership's business.
When the partnership can only be carried on at a loss.
When it is just and equitable to dissolve the partnership.
7. Notice of Dissolution:
In a partnership at will (where there is no fixed term), any partner can give notice of their intention to dissolve the partnership.
This notice must be communicated to all other partners.
8. Illegality:
If the partnership's business becomes illegal, the partnership is automatically dissolved.
For example, if the business is selling a product that is then banned, the partnership will be dissolved.
Consequences of Termination
Upon termination, the partnership's assets must be liquidated, and the proceeds distributed among the partners according to their agreed-upon shares.
The partners remain liable for any outstanding debts or obligations of the partnership.
Notification of the termination to any relevant third parties is also very important.
