Partnership and LLP formation - Partnership and LLP agreements

Learning Outcomes

After studying this article, you will be able to identify how partnerships and LLPs are formed, explain the legal significance of partnership and LLP agreements, distinguish between default statutory rules and tailored agreements, and compare the legal characteristics of partnerships and LLPs. You will also be able to advise on the practical and legal implications of having (or not having) a written agreement for both structures.

SQE1 Syllabus

For SQE1, you are required to understand the formation and regulation of partnerships and LLPs, and the role of partnership and LLP agreements. In your revision, focus on:

• The statutory definition and formation of partnerships under the Partnership Act 1890
• The creation and registration requirements for LLPs under the Limited Liability Partnerships Act 2000
• The legal effect of written and unwritten partnership and LLP agreements
• The default rules that apply in the absence of an agreement
• The comparison of liability, legal personality, and management in partnerships and LLPs
• The practical consequences of not having a formal agreement

Test Your Knowledge

Attempt these questions before reading this article. If you find some difficult or cannot remember the answers, remember to look more closely at that area during your revision.

1. What are the three elements required for a partnership to exist under the Partnership Act 1890?
2. Is a written agreement required for a partnership or LLP to be valid in law?
3. What is the main legal difference between a partnership and an LLP regarding liability for business debts?
4. If partners do not have a written agreement, how are profits and losses shared by default?
5. What is the effect of registering an LLP at Companies House?

Introduction

Partnerships and limited liability partnerships (LLPs) are common business structures in England and Wales. Understanding how these entities are formed and governed is essential for SQE1. This article explains the legal requirements for creating partnerships and LLPs, the significance of partnership and LLP agreements, and the consequences of relying on statutory default rules versus tailored agreements.

Formation of Partnerships

A partnership is defined by section 1(1) of the Partnership Act 1890 as "the relation which subsists between persons carrying on a business in common with a view of profit." Three elements must be present:

Key Term: partnership
A business relationship between two or more persons who carry on a business together with the intention of making a profit.

• Two or more persons: Can be individuals or companies.
• Business in common: Joint activity, not just shared ownership.
• View of profit: There must be an intention to make profit, even if none is actually made.

A partnership can arise without any formalities. There is no requirement for a written agreement or registration. In practice, a partnership may be created by conduct, oral agreement, or a written contract.

Key Term: implied partnership
A partnership that arises automatically by law from the conduct of the parties, even if there is no express agreement.

Default Rules and the Importance of Agreements

If the partners do not set out their own terms, the Partnership Act 1890 imposes default rules. These include:

• Profits and losses are shared equally (section 24(1)).
• All partners may participate in management (section 24(5)).
• No partner is entitled to a salary (section 24(6)).
• Unanimous consent is required to admit a new partner (section 24(7)).
• Ordinary matters are decided by majority, but changes to the nature of the business require unanimity (section 24(8)).

These default rules may not reflect the partners' intentions or contributions. Therefore, it is strongly recommended to have a written partnership agreement.

Key Term: partnership agreement
A contract between partners that sets out the terms of the partnership, including profit sharing, management, and dispute resolution.

Worked Example 1.1

Scenario: Three friends start a graphic design business together. They do not sign any agreement. One invests £10,000, the others invest nothing. After a year, the business makes £12,000 profit. How are profits shared?

Answer: By default, profits are shared equally, so each partner receives £4,000, regardless of capital contributed, unless a different arrangement was agreed.

Formation of LLPs

A limited liability partnership (LLP) is a hybrid structure created by the Limited Liability Partnerships Act 2000. An LLP combines features of a partnership with the benefits of limited liability and separate legal personality.

Key Term: limited liability partnership (LLP)
An incorporated business structure with separate legal personality, where members have limited liability for the LLP’s debts.

LLP Registration and Agreement

To form an LLP, the following steps are required:

• At least two persons must subscribe to an incorporation document.
• Registration at Companies House using form LL IN01, stating the LLP’s name, registered office, and members.
• Payment of the registration fee.

Once registered, the LLP becomes a separate legal entity. Members are not personally liable for the LLP’s debts (except in cases of fraud or wrongful trading).

There is no legal requirement for an LLP agreement, but it is highly advisable. Without an agreement, default rules in the Limited Liability Partnerships Act 2000 and associated regulations apply, which may not suit the members’ intentions.

Key Term: LLP agreement
A contract between LLP members setting out internal management, profit sharing, and other key terms.

Worked Example 1.2

Scenario: Four accountants form an LLP but do not sign an LLP agreement. One member works full-time, the others part-time. The LLP makes £80,000 profit. How is profit shared?

Answer: By default, profits are shared equally among all members, so each receives £20,000, regardless of hours worked, unless an LLP agreement provides otherwise.

Comparison: Partnerships and LLPs

Worked Example 1.3

Scenario: A partner in a traditional partnership signs a large supply contract on behalf of the firm. The business cannot pay. Who is liable?

Answer: All partners are jointly and severally liable for the full debt. Creditors can pursue any partner for the entire amount.

Exam Warning

If a partnership is created without a written agreement, the default rules may lead to unexpected results, such as equal profit sharing regardless of capital or effort. Always check for an agreement or clear evidence of contrary intention.

Key Features of Partnership and LLP Agreements

A partnership or LLP agreement allows the parties to override statutory default rules and tailor the business relationship. Common provisions include:

• Profit and loss sharing ratios
• Capital contributions and drawings
• Management structure and decision-making
• Admission and retirement of partners/members
• Dispute resolution procedures
• Expulsion and dissolution terms

Without a clear agreement, disputes may arise and the statutory defaults may not reflect the parties’ expectations.

Revision Tip

For SQE1, be able to identify when a partnership or LLP exists, explain the effect of not having a written agreement, and compare the liability and legal personality of partnerships and LLPs.

Key Point Checklist

This article has covered the following key knowledge points:

• The statutory definition and formation requirements for partnerships and LLPs
• The legal effect and importance of partnership and LLP agreements
• The default rules that apply in the absence of an agreement
• The differences between partnerships and LLPs in legal personality and liability
• The practical consequences of not having a formal agreement

Key Terms and Concepts

• partnership
• implied partnership
• partnership agreement
• limited liability partnership (LLP)
• LLP agreement