Contractors' Questions: How to wind-up a partnership?
Contractor’s Question: Having done some research online, I’m quite keen to set up a partnership with a fellow IT contractor but, if the business doesn’t work out, would the process to wind-up the partnership be complicated? I’ve read about the complexities of winding up a limited company but information for contractors on how to close down a general partnership (not a LLP), seems scant. What considerations should I make?
Expert’s Answer: As you probably know from your research, a partnership comes into force when two or more people start a business that does not have any other legal form such as a limited company.
Often there is a written Partnership Agreement which sets out how the business is to be run but, where there is not, it is governed by the terms of the Partnership Act 1890. Sometimes, Partnership Agreements only cover some important points but not others. Where this is the case, the Partnership Act fills in the gaps.
Unless there is a contrary agreement, a partnership will be an equal one where each partner shares equally in its profits and contributes equally to any losses.
Unlike limited companies, it is easy for a partner to end a partnership. They can do so by giving written notice, or even just by resigning if there are no written terms that the partnership will continue if a partner leaves. A partnership will also come to an end if the purpose of it has run its course; or if one of the partners becomes bankrupt or dies.
When a partnership comes to an end, it is called ‘dissolution’ and the partnership is said to be ‘dissolved.’ What then follows is the process of ‘winding up.’
As is the case with limited companies, winding-up essentially involves collecting in all the assets of the business, paying off the debts and then paying anything left over to the partners.
When collecting in the assets, there can be disagreements over which assets belong to the partnership and which belong to the partners. Essentially, any property that is brought into the partnership for the purpose of the partnership business is partnership property, as is any property brought with partnership money. It belongs to the partnership itself and not to the individual partners. An individual partner therefore does not have a call on such property, and must wait until there is a final distribution made.
Partners owe various duties to their fellow partners which will affect what the assets of the partnership are.
A partner must not carry on any business of the same nature as the partnership or compete with it unless the other partner(s) consent. If a partner did do this, then any profits made from the competing business are assets of the partnership and must be paid into the partnership during the course of it being wound up.
Similarly, a partner must not derive any personal benefit from any transaction concerning the partnership, or from using partnership property or any business connection. Again, if this is the case, then profits made are deemed to be assets of the partnership and must be paid into the partnership during its winding up.
Of course, if any money or other assets have been diverted from the partnership, then these too must be repaid during the course of a winding up.
Once all the assets have been collected in, the partnership’s liabilities must be paid. These will not just include trading debts but also debts due to employees and HM Revenue & Customs (for tax and VAT)
Once this had been done, there will either be a surplus left over or a deficit.
If there is a deficit, this must be paid firstly out of profits, then capital and lastly by the partners having to provide money in proportion to the share of the profits that they are entitled to.
If there is a surplus, then this is paid firstly to partners for any advances made, then to repay capital and finally a distribution in proportion to the share of the profits that they are entitled to.
If the partners cannot agree on matters concerning the dissolution or winding up of the partnership, then a court can intervene.
Sometimes, this may be necessary to determine whether the partnership has been dissolved and, if so, on what date.
The court can also determine what the assets of the partnership are and what partners must replay to the partnership (due to for example diverting partnership assets, competing with it or making a personal profit from using partnership assets or connections).
The court can also intervene to ensure that the winding up proceeds effectively.
When to get legal advice
If, following dissolution, you cannot agree with your fellow partner what assets must be repaid into the partnership, or whether something is partnership property, then you should take legal advice. Similarly, seek advice if a partner is blocking an effective winding up from taking place.
The expert was Gary Cousins, solicitor and founder of Cousins Business Law.
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