Shareholders Agreement and Partnership Agreement
Under English law the two main types of business partnership, where two or more people wish to own and/or manage a business together are:
- As a “general partnership”, subject to the Partnership Act 1890.
- Through a limited company, subject to the Companies Act 2006.
There are other forms of business partnership such as the Limited Liability Partnership, and more information can obtained through our page on Joint Ventures.
The general partnership and the limited company are completely different legal species.
The Partnership Act 1890
Under the Partnership Act 1890, a partnership will automatically come into existence between two or more persons as soon as their activities satisfy a very straightforward legal test, namely that they: “carry on business in common with a view to profit”. In other words, a general partnership can come into existence immediately through a handshake at a pub.
The Companies Act 2006
Under the Companies Act 2006, a company will come into existence when the relevant incorporation paperwork has been submitted to Companies House together with payment of the relevant fee, and Companies House issues a certificate of incorporation. In practical terms though, it is extremely easy to form a limited company.
The consequences of forming a legal partnership under the Partnership Act 1890
When entering into business with someone, all partners should be very clear on the consequences. There are three fundamental principles of partnership law:
- First, all of the partners are jointly liable for the debts and obligations of the partnership business. They are also joint and severally liable for the wrongful acts or omissions of the other partners in the ordinary course of the partnership business. It is for this reason alone that many business people prefer running a business through a limited company.
- Second, each of the partners has the right to participate in the management of the partnership business, unless the partners agree otherwise.
- Third, all partners are entitled to share equally in the capital and profits of the partnership and must contribute equally towards losses, unless the partners agree otherwise.
The consequences of forming a limited company
Key features of a private company are:
- The limited company is a separate legal entity in the eyes of the law. The company is the entity that enters into contracts with suppliers, customers and staff, not the shareholders. In a small limited company the shareholders are likely to be the same people as the directors. If the company were to become insolvent, then the shareholders will not be personally liable for the debts, unless in their position as directors, they have traded wrongfully or fraudulently.
- The management of a company is usually delegated to the directors alone, with a few residual decisions under company law which are reserved for shareholders alone to take. Directors can pass decisions based on a majority vote. Shareholders can pass decisions as ordinary resolutions (majority) or special resolutions (three quarter).
- Shareholders are entitled to share in the profits of the company in the form of a dividend provided the dividend is approved by the directors. The amount of the dividend will be based on the number of shares in the company.
Why have a partnership agreement or a shareholders agreement
Whether the relationship between the partners is genuinely a “general partnership” for the purposes of the Partnership Act 1890 or a “limited company” for the purposes of the Companies Act 2006, a partnership agreement or shareholders agreement as appropriate is strongly recommended.
The partnership agreement or shareholders agreement records the intentions of the partners or shareholders in business together. Without a partnership agreement or shareholders agreement there are standard default rules that will apply, but these are likely to always need some amendment.
Significant and long term partnerships between may need fairly comprehensive partnership or shareholder documentation to provide rules concerning the inevitable ups and downs of business life.
Areas covered in a Partnership Agreement and Shareholders Agreement
A partnership agreement and shareholders agreement can cover numerous areas, and become a fairly substantial constitutional document in their own right. However, the following are the key areas that we recommend are included in all partnership agreements or shareholder agreements:
- Ownership of the assets i.e. will ownership of all assets be in the name of the business or the partners individually.
- Decision making rules. So, for example, which partners or shareholders can sign cheques? Which partners or shareholders can bind the business to contracts? How often will the partners or shareholders have to meet? If the business is deadlocked, then how is the deadlock to be resolved?
- What contributions do the partners or shareholders need to make? For example, will the partners or shareholders be required to contribute to the business from their own funds? Will they be required to work full time?
- If a partner or shareholder dies then what are the pre-emption provisions in terms of offering the deceased partner or shareholders’ share in the business back to the surviving partners or shareholders? What price should be provided? How will the valuation be decided? Will life insurance be required to fund the purchase of the deceased’s share?
- Exit planning generally. For example, will the partnership agreement or shareholders agreement include a right for the partners or shareholders to sell their stake at any time? Will the remaining partners or shareholders be required to buy-back the partners or shareholders who chooses to depart at any time? What happens if the relationship between the partners or shareholders breaks down, or one party suffers a serious accident or illness?
For specialist business law advice contact us by telephone on (020) 8275 0336 or by email at email@example.com.