Partnering Up: Partnership Law and Financial Remedy Proceedings

The Department for Business & Trade’s most recent Business Population Estimates suggested that there are approximately 356,000 ordinary partnerships currently trading within the United Kingdom, generating a turnover of just under £1 billion. The majority of these are small enterprises involving either no or fewer than ten employees.

It is therefore likely that partnerships will feature in financial remedy (FR) cases with some frequency. Either one or both parties may be a member of a partnership from which they draw an income or could be entitled to capital.

However, in our experience, whilst both partnership law and partnership accounting practices are substantive specialities in their own right, there is much less familiarity with them amongst those who are involved in FR cases than other areas of civil law which can arise in FR proceedings.

This article is therefore aimed at providing an introduction to some of the issues which may arise to help give readers confidence as to where to start when assessing these cases.

Introduction

What is a partnership?

The Partnership Act 1890 (PA) defines a partnership as the relation which subsists between persons carrying on a business in common with a view to profit.[[1]] ‘Business’ has an extremely wide definition including ‘every trade, occupation, or profession’.[[2]] There are a number of cases exploring the outer parameters of what is meant by ‘in common’ and ‘a view to profit’.[[3]] A dispute might be whether two relatives are carrying out a business in common or whether it is merely a business of one of them assisted by another.

Whilst a partnership shares some characteristics with both companies and unincorporated associations, it should be thought of as a category in and of itself. The partnership is somewhat more than a simple contractual relationship between the partners. It imposes upon the partners continuing personal and commercial relationships under both common law and the PA.[[4]]

Partnerships can be any size, and some are very large organisations. However, what tends to set them apart from limited companies is the lack of separation between ownership and management; they are rarely just investments.

Types of partnerships

The most common type of partnership in England and Wales is an ordinary partnership which arises in the circumstances considered below. Such partnerships do not need to be incorporated or registered and generally lack legal personality. This means they cannot hold property in their own name, relying instead on one or more of the partners to hold it on trust.

As a result, if the only two partners are the parties themselves, it is unlikely that the court will need to explore partnership law in detail to resolve the FR proceedings between them, instead tacking the underlying assets directly.[[5]]

Less-common is the limited partnership (LP), established by the Limited Partnership Act 1907. They have some popularity as investment vehicles. Unlike ordinary partnerships they must be registered with Companies House.[[6]] The principal difference between an LP and an ordinary partnership is that an LP will contain an additional category of partner, known as limited partners, who have limited liability and are excluded from management functions. It seems likely that these will be treated like other investment assets in FR cases.

A third type is the limited liability partnership, incorporated under the Limited Liability Partnership Act 2000. They, too, must be registered. However, despite their name, they are not strictly partnerships, though many partnership considerations apply due to the nature of the relationship between the members. Instead, they are incorporated bodies in which the partners enjoy limited liability in return for much of the regulation applied to companies.

Other jurisdictions have devised many variations of partnership and so caution and specialist advice will be needed on encountering one.

In the remainder of this article, when referring to a partnership we mean an ordinary partnership, unless otherwise indicated.

How might a partnership arise?

No specific formality is required for the formation of a partnership. Whilst written partnership agreements are best practice and common in many areas (e.g. amongst professional partnerships such as those formed between solicitors, accountants, GPs or pharmacists or some agricultural partnerships), they are not a pre-requisite. Instead, a partnership may arise informally or even unintentionally from conduct.

In determining whether a relationship is that of a partnership or not, the court is directed to consider a number of rules. These are set out in s 2 PA. The most important of these is that receipt by a person of a share of the profits of a business is, subject to some exceptions, prima facie evidence that they are a partner in the business.

One of the exceptions which is significant in FR cases can be found in s 2(1). This provides that joint or part ownership of property, and the sharing of profits generated by it, does not, of itself, generate a partnership. The effect of this is that if one of the parties jointly owns one or more investment properties with others, they are unlikely to be in a partnership arrangement, even if they share the profits of that investment.

Partnership agreements

Ideally, each partnership will be governed by a comprehensive written partnership agreement which will give definitive answers to many of the questions that arise in FR cases, such as how the partnership’s income, assets and capital should be shared between the partners and the process for leaving or dissolving the partnership.

However, there is no general requirement to draw up a partnership agreement and it is not uncommon for family partnerships to operate without one. In this case the partnership will be governed by the statutory framework of the PA; the agreements the court can imply by the partners’ conduct; and common law.

Indeed, this flexibility extends further: even where a partnership agreement has been executed, the partners may deviate from this by unanimous consent. Again, whilst this consent may be recorded by formal written amendments to a partnership agreement, there is no obligation to do so, and such amendments may instead be inferred from the partners’ course of dealing.[[7]]

As a result, compared to businesses incorporated as companies, looking at what has happened in practice can be particularly important. A divergence from what is provided for in the partnership agreement could reflect an amendment by conduct rather than a breach of the agreement.

Partnership accounts

Partnership accounts pose particular problems to the FR lawyer. There are two principal challenges. First, best practice for partnership accounting is unintuitive. Secondly, best practice is often not followed. As a result, even if formal accounts have been prepared by a regulated accountant (who is often more used to dealing with limited companies), they may not shed much light on the questions which the Family Court will need to ask.

The partners’ accounts

In an ideal world, partnership accounts should provide two separate accounts for each partner: a capital account and a current account.

The capital account represents the partner’s net contribution to the capital of the business. As such, it is a fixed amount that will not vary merely as a result of the business trading. It represents the sum that the partner would be entitled to receive on dissolution of the partnership were the partnership’s assets equal to the sum of the partners’ capital accounts at that moment. In the event that an asset is revalued during the course of the partnership, the result may be a capital profit or loss that may be reflected in the capital account balance.

At the inception of the partnership, a capital account could include, for example, cash or the cash value of any land or machinery which is invested in the business. It is not necessary for the contributions to be equal and it may be possible that the entire partnership capital is held by one person.

Adjustments to the partnership capital may only be made with the consent of the partners. As a result, a partner cannot generally realise the sums in his capital account without agreement.

As the partnership trades, sums may be added to the capital accounts but this, too, must be by agreement. A common difficulty arises with undrawn profits. They may be added to a partner’s capital account or not. If they are, then the effect of this capitalisation is that a partner may not draw the sums without the agreement of the other partners[[8]] or dissolving the partnership. If they are not, the partner may be entitled to draw them forthwith.

The current or drawings account should record the partner’s money within the business which has not been capitalised. In the simplest scenario, it will show an annual credit for the partner’s share of the profits and then debits as the partner withdraws it (or, more likely, debit drawings on account of profits anticipated in that year, with credit for profits at the end of the year). If a partner does not draw the full amount, then the balance may be carried to future years or be capitalised and so debited from the current account and credited to the capital account. Similarly, drawings which exceed the partner’s entitlement may result in the current account showing a negative balance at the end of a year and an obligation to repay the over-drawings within a certain time period.

The partnership’s accounts

In addition to the partners’ accounts, the partnership as a whole will usually provide accounts, too, often in more familiar forms of a balance sheet or asset account and profit and loss account.

The balance sheet or asset account is perhaps the more important document since it should reflect the value of the combined assets of the partnership. In an established business, this may not represent the true value of the assets and liabilities as, by accounting convention, it will include assets at the lower of cost and net realisable value rather than actual market value, and certain assets, such as goodwill, are not included at all. In that case, the difference between the two can reflect an additional fund, which may only be realised on a dissolution and is usually shared between the partners in accordance with the way in which the profits are divided rather than how the capital is to be divided.[[9]] If a partner is entitled merely to be repaid the balance on their capital account when they leave then they may lose out on their fair share of surplus assets.

Common problems with accounts

It is not uncommon for there to be no separate current and capital accounts for each partner or for there to be a single capital account for the whole partnership. As a result, it may not be clear to the court what sums might be available to the partner immediately and what has been capitalised and so can only be realised on dissolution or retirement. Similarly, if the partners’ capital accounts have not been separated, then the court will need to look to external evidence to make an assessment as to whether the intention was for the capital to be shared jointly between the parties or not.[[10]] If it is joint, then the usual equitable principles of the sharing of jointly owned property would apply at dissolution. If not, then the court will need to determine how the partners agreed for it to be shared.

Reconstructing accounts

Since there is no general obligation on an unincorporated partnership to produce accounts in accordance with best practice or, indeed, any accounts at all, it may be necessary to instruct a forensic accountant, at an early stage, to rebuild them.

In theory, there should be no difficulty in obtaining the underlying financial information for this exercise since there is a statutory right of inspection of the partnership books by any partner[[11]] and an obligation to render true accounts.[[12]] In practice, however, the lack of formality can make it almost impossible to reconstruct accounts going back many years.

Care will need to be given as to the letter of instruction since, as set out above, the partnership agreement may be inferred from conduct. There should therefore be complete clarity as to whether the accountant is being invited to reconstruct accounts from an agreed position as to the division of capital and profits or, instead, should report to the court as to what inferences might be drawn as to the nature of the agreements from what has taken place.

Partnership property and third parties

A self-contained area of dispute which may arise in FR cases is where property, usually land, is legally held by one party but it is claimed that it belongs instead to a partnership and is therefore not available for distribution by the court. Because partnership property must be held by one or more of the partners (due to the lack of separate legal personality) it can be difficult to determine whether the intention was that it be held on trust.

This is conceptually similar to claims by third parties that property in the name of a party is in fact held by them on an unregistered trust. However, the legal principles are not governed by equity but rather the statutory tests under ss 20 and 21 PA. These provide:

‘20 Partnership property.

(1) All property and rights and interests in property originally brought into the partnership stock or acquired, whether by purchase or otherwise, on account of the firm, or for the purposes and in the course of the partnership business, are called in this Act partnership property, and must be held and applied by the partners exclusively for the purposes of the partnership and in accordance with the partnership agreement. …

21 Property bought with partnership money.

Unless the contrary intention appears, property bought with money belonging to the firm is deemed to have been bought on account of the firm.’

The questions that therefore arise are:

• For property which pre-dated the partnership, was it brought into the partnership stock or acquired on account of the firm?
• For property which post-dates the partnership, was it bought by money belonging to the partnership and, if so, is there a contrary intention?

Documentation may resolve this dispute. If the partnership capital accounts account for certain property, it is likely that the property was brought into the partnership stock. Alternatively, if there are express declarations of trust (e.g. on the TR1) indicating ownership is held in another way, then that may be determinative.

If not, the court will need to look to what other evidence is available but is encouraged to exercise particular caution in trying to infer or imply agreements and limit such inferences to what is absolutely necessary to give business efficacy to what has happened.[[13]] For example, simply because a partnership uses a partner’s land for trading purposes, that does not necessarily imply that such land has been brought into the partnership. It may, instead, be merely using it. Equally, inclusion of property in the annual accounts (even if it is clear precisely what the scope of that property is) is not determinative.

There are a large number of cases exploring these issues which it may be helpful to consult when faced with a dispute of this nature. For example, Merryman v Merryman [2024] EWFC 58 (B) – a rare example of an FR case which considered the PA – or Wild v Wild & Ors [2018] EWHC 2197 (Ch).

Procedure

The procedure set out in TL v ML & Ors (Ancillary Relief: Claim Against Assets of Extended Family) [2005] EWHC 2860 (Fam), [2006] 1 FLR 1263 which is familiar from third-party ‘intervention’ cases should apply to disputes of this nature.

The partnership as a source of capital

The first question which often arises in FR cases involving a partnership is whether capital may be extracted from the business to, for example, provide for a housing or other fund to one party.

Many of these issues are the usual ones encountered in any cases where there is an income generating asset:

• if it is sold to generate capital, this may adversely impact the parties’ income needs;
• alternatively, if it is not sold but credited to one party’s side of the matrimonial balance sheet, it may represent an unfair distribution of the copper-bottomed vs illiquid or risk-laden assets.[[14]]

However, there are some additional partnership-specific considerations.

Valuation

The difficulties in valuing business assets in FR proceedings are well known and the general considerations will apply to partnerships as much as they do to companies.[[15]] These include the fact that the partnership may in fact have no capital value at all if it is just a conduit for income from partners providing professional or similar services.

Whilst a partnership may be valued by any of the usual methods (e.g. a market or income basis), it is likely that an asset basis will be most appropriate in FR cases since there are significant difficulties with selling unincorporated partnerships which are inextricably linked with the partners who operate them. It is likely to be an exercise in double-counting to look to a party’s income from a partnership as both an income stream and creating their value in the partnership.[[16]] An asset basis, by contrast, will show what the partner is likely to receive on dissolution of the business.

Once the partnership has been valued, the proportion of the assets that a partner will receive on dissolution[[17]] is calculated as follows: once the partnership’s debts have been paid, each partner will receive, first, their capital account balance followed by a net share of any remaining assets, distributed in accordance with how profits are shared, set off against any sums they owe the partnership.

Realisation

When considering businesses within FR proceedings, the court has three practical options: leave it unsold but fix its value for the matrimonial balance sheet; order it be sold; or divide the asset in specie (sometimes called ‘Wells sharing’).[[18]]

For a partnership, the first option, of course, remains available. It is perhaps the simplest method of dealing with the value of the partnership, particularly if only one party is a partner and it is agreed that the business should continue to trade.

As to selling a share of the partnership, this remains legally possible, subject to any express provision within the partnership agreement. The share may be sold either to another partner or a third party. However, the effect of such a sale to a third party only entitles the assignee to receive the share of the profits to which the assigning partner was entitled and does not grant a right to the assignee to interfere in the management of the business.[[19]] As a result, it may not be a realistic option.

In those circumstances, perhaps the most likely route for extracting capital from a partnership by sale is to dissolve it.[[20]] This process can be straightforward in the case of a partnership where there is no written partnership agreement. Such a partnership is a partnership-at-will and may therefore be dissolved simply by notice.[[21]]

In other cases, the procedure should be found within the partnership agreement, although the court retains the power to dissolve a partnership for five specific grounds, including that it is ‘just and equitable’ to do so in the circumstances of the case.[[22]] Whilst there appears to be no authority on the point, the definition of ‘court’ within the PA is wide and includes ‘every court and judge having jurisdiction in the case’. It is therefore at least arguable that the Family Court could exercise this power, having joined the remaining partners, in order to give effect to its powers under s 24A MCA and avoid satellite litigation in the High Court.

Formally, the dissolution of a partnership should result in the sale of the assets and their distribution, although some of the partners may instead apply for an order that they are permitted to buy the share for a fixed price determined by the court.[[23]] In practice, if a buy-out is possible and likely, it may be achieved by negotiation.

Lastly, since a share of a partnership may be assigned, subject to any explicit provision in the partnership agreement, it appears there is no principled reason why the share could not be shared between parties, in the form of Wells sharing. The usual disadvantages of this as to the lack of a clean break will apply.

The partnership as a source of income

If the partnership is not to be dissolved or sold, then the court may look to it as a source of income. Partners may draw an income from a partnership in a number of different ways.

Share of profits

The share of profits represents the most traditional way in which income is drawn from a partnership.

Unlike a dividend paid by a company, the share of profits which each partner is entitled to is usually set by agreement amongst the partners rather than by reference to each partner’s share of the partnership capital. This may be set out in the partnership agreement but if it is not, it may be inferred by conduct. In the event that that is not possible, the court will fall back on the statute, which provides a rebuttable assumption that profits will be shared equally.[[24]]

Due to the flexibility as to how profits are shared, it may be that one partner holds the majority of the capital in the partnership but will only take a small share of the profits. There may be legitimate reasons for this, such as if the partner has contributed land to a farming partnership but takes no part in the day-to-day farming. However, practitioners should be alive to agreements being structured artificially to minimise the divorcing partner’s share and whether submissions should be made that the foreseeable future income will be higher, once proceedings have been resolved.

Additionally, as with any profit-dependant income, the sums are likely to fluctuate from year to year but care should still be taken to check they have not been artificially depressed during and immediately before the FR proceedings.

Salary

In addition to sharing profits, the partners may agree that some or all of them may receive a fixed sum each year. This may be common if, for example, only some partners are carrying out the day-to-day work of the business. This is usually called a ‘salary’ but may be better thought of as a fixed or prior share of the profits. It should not be confused with ‘salaried partners’, who are employees merely held out as partners and receive a guaranteed payment for their work.

Drawings

Drawings are sums paid by the partnership to a partner. These are often regular monthly payments, but may in addition be other sums paid to them or on their behalf for which they will have to account. The usual question is whether the partners have agreed for them to be debited against the partner’s capital account so that they only crystallise at dissolution or may be paid from incoming profit shares, affecting the balance on their current accounts.

Conclusions and further reading

An article of this nature can only scratch the surface of partnership law and provide a general introduction to a complex subject. We therefore think it is essential that, before any advice is given or arguments are deployed in court, practitioners should consult the specialist literature. The main textbook is Lindley & Banks on Partnership[[25]] but there are a number of other general and specialist works.

[[1]]: ⁠PA, s 1(1).⁠

[[2]]: ⁠PA, s 45.⁠

[[3]]: ⁠See Roderick I’Anson Banks, Lindley & Banks on Partnership (Sweet & Maxwell, 21st edn, November 2024), Chapter 2.⁠

[[4]]: ⁠Hurst v Bryk [2002] 1 AC 185 at 194 per Lord Millet.⁠

[[5]]: ⁠Similarly to the lack of usual need to resolve and declare the parties’ equitable interests in property. See DDR v BDB (Financial Remedies, Beneficial Ownership and Insolvency) [2024] EWFC 278.⁠

[[6]]: ⁠Limited Partnership Act 1907, s 5.⁠

[[7]]: ⁠PA, s 19. It is generally thought possible to exclude this provision by express wording in the partnership agreement that any amendments should be in writing.⁠

[[8]]: ⁠See, e.g. Heslin v Hay (1884) 15 LR IR 431.⁠

[[9]]: ⁠PA, s 44(b)(4).⁠

[[10]]: ⁠Hopper v Hopper [2008] EWCA Civ 1417 at [22].⁠

[[11]]: ⁠PA, s 24(9).⁠

[[12]]: ⁠PA, s 28.⁠

[[13]]: ⁠Miles v Clarke [1953] 1 WLR 587 at 540.⁠

[[14]]: ⁠See, e.g. HO v TL [2023] EWFC 215 at [26].⁠

[[15]]: ⁠See, e.g. Duncan Brooks KC, ‘Businesses in Financial Remedy Claims’ [2024] 1 FRJ 3.⁠

[[16]]: ⁠See, e.g. Smith v Smith [2007] EWCA Civ 454 at [30].⁠

[[17]]: ⁠Before tax and subject to anything to the contrary in the partnership agreement.⁠

[[18]]: ⁠Martin v Martin [2018] EWCA Civ 2866 at [93].⁠

[[19]]: ⁠PA, s 31.⁠

[[20]]: ⁠There are also some complicated considerations in respect of NHS GP Practices due to a statutory prohibition on sale of goodwill: Rodway v Landy [2001] Ch 703.⁠

[[21]]: ⁠PA, ss 26(1) and 32(c).⁠

[[22]]: ⁠PA, s 35.⁠

[[23]]: ⁠Usually called a ‘Syers v Syers order’ after the case reported at (1875–76) LR 1 App Cas 174 HL.⁠

[[24]]: ⁠PA, s 24.⁠

[[25]]: ⁠See n 3 above.⁠