Partnership and LLP formation - Partnership and LLP agreemen...

Learning Outcomes

This article outlines partnership and LLP formation, agreements, authority, and liability, including:

• When a partnership arises under the Partnership Act 1890, including the minimum elements of business, common control, and profit motive, and how section 2 indicators are used in exam fact patterns.
• The key differences between ordinary partnerships and LLPs in creation, legal personality, member/partner liability, regulation, and insolvency exposure.
• The role, structure, and legal effect of written partnership and LLP agreements, how they displace statutory default rules, and typical clauses tested in SQE1 scenarios.
• Partners’ and LLP members’ actual and apparent authority, the firm’s liability to third parties in contract and tort, and how agency, “holding out,” and notice operate in problem questions.
• The risks of “holding out,” the continuing liability of outgoing partners, and the impact of retirement without proper actual and Gazette notice under section 36 PA 1890.
• Core agreement terms on profit sharing, capital contributions, drawings, decision‑making, expulsion, restrictive covenants, retirement, valuation and payment of an outgoing share, and dispute resolution.
• LLP‑specific governance issues, including designated member responsibilities, registration and filing requirements, authority limits, and the LLP’s ability to own property and grant security.
• The practical consequences of operating without a formal agreement in both structures, such as default equal profit sharing, universal management participation, inability to expel, and dissolution triggers.

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, with a focus on the following syllabus points:

• The statutory definition and formation of partnerships under the Partnership Act 1890, including section 2 indicators of partnership and partnership names/business disclosure
• Partners’ agency and authority under sections 5–18 PA 1890; firm liability for torts (section 10), misapplication (sections 11–12), “holding out” (section 14), and outgoing partner liability including notice under section 36
• The default terms in sections 24–25 PA 1890 (equal profit sharing; indemnity; interest on advances; management; expulsion)
• The creation and registration requirements for LLPs under the Limited Liability Partnerships Act 2000 and the LLP Regulations 2001; designated member responsibilities
• The legal effect of written and unwritten partnership and LLP agreements and how they displace default rules
• The comparison of liability, legal personality, and management in partnerships and LLPs, including insolvency‑related exposure (e.g. wrongful trading)
• The practical consequences of not having a formal agreement (equal shares, inability to expel, dissolution by death/bankruptcy, notice issues on retirement)

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. It also highlights authority and liability to third parties, retirement notice requirements, and LLP governance features such as designated members and filings.

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. There is no upper limit on partner numbers.
• Business in common: Joint activity with shared control or participation, not merely co‑ownership or isolated dealings.
• 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.

Section 2 PA 1890 provides guidance when determining whether a partnership exists (e.g. sharing profits is prima facie evidence of partnership but not conclusive). The name of a partnership is not registered at Companies House, but business names are regulated under the Companies Act 2006, Part 41 (including rules on sensitive words and disclosure of key information on business stationery).

Key Term: partnership at will
A partnership with no fixed term or specific dissolution provisions; any partner may end it by notice to all other partners.

Partners’ Authority and Liability to Third Parties

Under section 5 PA 1890, each partner is an agent of the firm and other partners. A partner with actual or apparent authority can bind the firm in contracts made in the ordinary course of the partnership business. The firm is also liable for wrongful acts of partners committed in the ordinary course of business (section 10) and for misapplication of money or property received (sections 11–12).

Key Term: actual authority
Authority expressly or impliedly conferred by the partners or under the agreement, allowing a partner to bind the firm.

Key Term: apparent authority
Authority that a partner appears to have to a reasonable third party, arising from the nature of the business and how the firm holds the partner out.

Key Term: holding out
Under section 14 PA 1890, a person (including a former partner) who represents or allows themselves to be represented as a partner may be liable to third parties who gave credit in reliance on that representation.

Outgoing partners remain liable for debts incurred while they were partners (section 17). To avoid liability for future debts, an outgoing partner must ensure actual notice is given to existing counterparties and advertise the retirement in the Gazette (section 36) to notify persons who had not dealt with the firm before.

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)).
• The firm must indemnify partners for payments made and liabilities incurred in the ordinary course of business (section 24(2)).
• Interest is payable on advances (loans) made by partners beyond capital (section 24(3)); no interest on capital contributions unless agreed.
• 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)).
• Partnership books are to be kept at the principal place of business and be accessible to partners (section 24(9)).
• No power to expel a partner without an express agreement (section 25).
• A partnership at will may be terminated by notice; death or bankruptcy of a partner dissolves the partnership unless agreed otherwise (sections 26, 33).

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, capital, management, authority, retirement, and dispute resolution.

Tailored agreements typically address profit ratios, interest on capital, drawings, management roles, authority limits, expulsion, retirement and payment of the outgoing partner’s share (including valuation and goodwill), restrictive covenants, and deadlock resolution. They also define processes for giving notices (e.g. retirement) and help prevent “holding out” after departure.

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.

Unlike an ordinary partnership, an LLP is formed only by registration at Companies House. At least two persons must subscribe their names to the incorporation document, and form LL IN01 must be filed specifying the LLP’s name, registered office, jurisdiction (England and Wales, Wales, Scotland or Northern Ireland), and details of members. On registration, the LLP becomes a body corporate (LLPA 2000, section 1(2)).

Members are agents of the LLP (LLPA 2000, section 6). The LLP itself, not the members, is liable for debts and obligations of the business. However, insolvency law applies to LLPs broadly as it does to companies: designated members can face exposure for wrongful trading (Insolvency Act 1986) and may be subject to disqualification orders (Company Directors Disqualification Act 1986).

LLPs must comply with corporate filing and disclosure requirements (e.g. annual accounts and confirmation statements; notifying Companies House of changes to membership within 14 days). LLPs can own property, grant fixed and floating charges, and must register charges in accordance with the applicable regime.

Key Term: designated member
An LLP member with additional statutory responsibilities (e.g. filings, accounts, confirmation statements, and compliance), similar to certain company officers’ functions.

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 (identifying designated members—either all members or at least two must be designated).
• 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 such as wrongful trading or where personal guarantees are given).

There is no legal requirement for an LLP agreement, but it is highly advisable. Without an agreement, default rules in the LLP Regulations 2001 (which substantially mirror partnership law defaults) apply. Typically, these default provisions include equal sharing of capital and profits, the ability of each member to take part in management, no entitlement to remuneration, majority decisions on ordinary matters, unanimity for changing the nature of the business and for varying the agreement, and—commonly in practice—unanimous consent to admit a new member.

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

Practical governance is enhanced by clearly defining designated members’ roles, decision‑making processes, authority thresholds for contracts and borrowing, leaving provisions (including payment terms for outgoing members), and dispute resolution. Because an LLP has separate personality and can grant floating charges, agreements often include tailored borrowing and security clauses alongside authority limits.

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

LLPs are generally regulated by company and insolvency law in addition to the LLPA 2000, and can grant fixed and floating charges. Members of LLPs can be disqualified under the CDDA 1986; ordinary partnership partners cannot be disqualified under that Act.

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, inability to expel a problem partner, or dissolution on death/bankruptcy. In the LLP context, the absence of an agreement may leave equal sharing and open management participation in place, which can be inappropriate for professional firms. Always check for an agreement, authority limits, and—if advising an outgoing partner—whether notice requirements under section 36 PA 1890 have been properly satisfied to avoid future liability and “holding out”.

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, interest on capital and loans, and drawing policies
• Capital contributions, capital accounts, and repayment terms on retirement
• Management structure, decision‑making thresholds, and reserved matters
• Authority limits for contracts, borrowing and security; use of bank mandates
• Admission and retirement of partners/members; valuation of an outgoing share, goodwill treatment, and payment mechanics
• Restrictive covenants (non‑compete, non‑solicitation), confidentiality, and IP ownership
• Expulsion grounds and process, with majority thresholds and fair‑procedures clauses (expulsion requires express agreement in a partnership)
• Dispute resolution procedures (mediation/arbitration) and deadlock resolution mechanisms
• Risk management clauses (insurance, limits on personal guarantees) and compliance (accounts, filings, tax)
• Notices (including retirement and change‑of‑role notices) and measures to prevent “holding out” post‑retirement
• LLP‑specific governance: identified designated members and their responsibilities; processes for changing membership and notifying Companies House; authority for granting charges

Worked‑through processes for retirement are especially important in partnerships to avoid inadvertent dissolution, to ensure payment to the outgoing partner, and to reduce exposure by complying with section 36 PA 1890 (actual notice to known counterparties and Gazette notice for others).

Key Term: partnership at will
A partnership that can be ended at any time by notice; without agreement, death or bankruptcy dissolves it automatically.

Key Term: designated member
An LLP member with extra statutory filing and compliance responsibilities.

Worked Example 1.4

Scenario: A two‑partner partnership has no written agreement. One partner wishes to remove the other for poor performance. Can they expel the partner?

Answer:
No. There is no default power to expel under PA 1890. An expulsion clause must be expressly agreed. Without it, the only options are to dissolve the partnership or negotiate departure terms.

Worked Example 1.5

Scenario: A three‑partner firm operates without a written agreement. One partner retires. No notices are given, and her name remains on the firm’s website and stationery for months. A supplier later contracts with the firm. Is the retired partner exposed?

Answer:
Yes, potentially. Without actual notice to existing counterparties and a Gazette notice for others (section 36 PA 1890), and with continued “holding out” (section 14), the retired partner may be liable for future debts incurred after retirement.

Revision Tip

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. In partnership questions, analyse authority (actual/apparent), firm liability in tort, the effect of “holding out”, and retirement notices under section 36. In LLP questions, check designated member responsibilities, filings, and whether an LLP agreement modifies default equal sharing and management participation.

Key Point Checklist

This article has covered the following key knowledge points:

• The statutory definition and formation requirements for partnerships and LLPs
• The relationship between partners and third parties: agency, actual/apparent authority, and “holding out”
• The legal effect and importance of partnership and LLP agreements and the defaults they displace
• The default rules that apply in the absence of an agreement (sections 24–25 PA 1890; LLP Regulations)
• The differences between partnerships and LLPs in legal personality, liability, authority, and regulation
• Retirement and notice requirements in partnerships (section 36 PA 1890) and their practical significance
• LLP governance: designated members, filings, and ability to own property and grant floating charges
• The practical consequences of not having a formal agreement (equal sharing, inability to expel, dissolution on death/bankruptcy)

Key Terms and Concepts

• partnership
• implied partnership
• partnership agreement
• partnership at will
• actual authority
• apparent authority
• holding out
• limited liability partnership (LLP)
• designated member
• LLP agreement