Farming partnerships: Why a gentleman’s agreement won’t cut the mustard
This article was first published on Devon Live on 25 January 2018 and is reproduced by kind permission.
The consequences of not having a written contract can be crippling. An enormous number of farming partnerships, many of which are vibrant and successful commercial businesses, operate without a written partnership agreement.
Many more operate on the basis of historic agreements which are no longer fit for purpose.
In the absence of a written agreement, (or if the written document doesn’t deal with everything) the default provisions under the Partnership Act 1890 will apply, as follows:
- The partners are entitled to share equally in the capital and profits of the business and must all contribute equally towards losses (capital and income)
- The death or bankruptcy of a partner will trigger the dissolving of the partnership (dissolution).
- The retirement of a partner will trigger dissolution if the arrangement is a partnership at will (rather than for a fixed term).
- On dissolution, the continuing partners have no right to buy the outgoing partner’s share – the default provision is that the partnership must be wound up under section 44 and the assets sold, with each partner entitled to be paid out their share of capital, once debts and liabilities have been settled.
The Partnership Act 1890 will apply subject to any agreement between the partners to the contrary. The Act therefore allows the partners to vary their mutual rights and duties.
Issues for partners to consider
Given the often inappropriate ‘default’ provisions under the Act, it is hugely important that partners consider what will happen on their death, retirement or incapacity and, crucially, that they discuss and agree the provisions that will apply in those scenarios and properly document that agreement.
This is not just a legal matter – the partnership accountants, farming consultants/agents and lawyers all need to be involved in advising on these issues which raise a number of complex considerations:
- Is the outgoing partner’s share to be valued at book value or market value?
- Who is responsible for valuing the share? Is their decision binding?
- How is the purchase of their share to be financed?
- What time frame/process is to apply to the purchase?
- If instalments are to be used, do they fit in with the business cash flow?
- What do the partners’ wills say? Any wider agreement reached in relation to the partnership needs to be reflected in the individual partners’ succession planning. Partners commonly bequeath their partnership share on death – should this only be permitted to continuing partners or does it extend to non-farming family members? In the latter case, should they be permitted to join the partnership or does their right only extend to being paid out the capital value of the outgoing share?
- Last but not least, what tax consequences flow from all of this?
Importance of written partnership agreement
The importance of a well drafted written partnership agreement cannot be overstated, particularly in the context of farming businesses where valuable land and capital assets are commonly held within the partnership structure. This can cause huge complications on death or retirement if matters have not been discussed, understood and agreed in advance.
Partnerships are rarely just trading entities – more often they are vehicles which regulate the ownership of significant assets and wealth between the partners and farming families.
Partnership documentation should be reviewed regularly, and at the very least, on the purchase of new land or significant assets, or the introduction of new partners.
In the absence of a clear written agreement, partners are effectively hoping that a sensible agreement can be reached between the family at the relevant time.
If this isn’t achieved, the results can be catastrophic for the business, to say nothing of family relationships, and can often lead to ‘last resort’ litigation for an order to wind-up the business and sell the assets.