Partners agreements

General provisions

The nature of the agreement between the partners or directors of a firm is dependent upon the size of the firm and also upon the things that the partners consider important. Some agreements place emphasis on provision for retiring partners and for the widows of deceased partners. Others may make provision for partners to be engaged in other businesses, while others make extensive provision for holidays and long-service leave.

The size of the firm is important too, and the biggest difference is between a two-person practice and a firm of any other size. For example, a multi-partner firm may need provisions to expel one partner and leave the partnership intact. Where there are only two partners, the withdrawal from the partnership of one partner necessarily means that the partnership comes to an end.

Recitals

The agreement will usually state the names of the parties, that they are in business together (or that they intend to commence), the nature of the business (eg architecture and town planning), the name and address of the business and that they intend to continue in business.

Property

The agreement needs to say by whom any partnership property is owned and in what proportion, and also in what proportion the partners contribute to increases in capital or capital losses. These two proportions will usually be the same.

If extra capital is provided by one partner, it is usually credited to that partner. Provisions for interest upon the capital, notice for withdrawal and a power by the other partner(s) to require withdrawal are also common provisions.

Votes

Where the property or profit share is unequal, it is sensible to make provision for the way in which partnership business should be controlled. For example, partners may have one vote each regardless of property and profit shares, or the votes may be in proportion to the profit shares. Also, the required voting majority for various decisions (resolutions) relating to partnership business needs to be specified. For instance, most matters may require just a simple majority vote (ie greater than 50%), while a higher majority could be stipulated for key decisions (such as the admission of a new partner or the acquisition of another firm or of material assets). It will be useful to include voting procedures. Normally, resolutions would be put to the vote at partners’ meetings, so setting out procedures in the agreement for the holding of such meetings is desirable. Often, for expediency, an alternative permitting resolutions to be passed in writing (by having all partners, or the partners holding the required number of votes, sign a document) is also included.

Management committee

In large partnerships, it may be appropriate to delegate certain functions relating to the management of the partnership to a management committee, which could be comprised of a number of partners elected by the partnership as a whole, or appointed according to some specified criteria. The sorts of matters that might be delegated to a management committee of a large partnership include the determination of the amount and timing of partners’ drawings of partnership funds as advances of distributions of profits, and the keeping of financial records and the preparation of financial accounts.

Partners’ work

Some provision should be made regarding the time that partners spend on partnership business and whether they are entitled to be engaged in other business. Some agreements say that partners should devote their whole time and attention to the partnership business and are not entitled to engage, directly or indirectly, in other business or professional appointment. Others provide that the partners should devote such of their time and attention to the partnership as is agreed by the partners, or provides that the partners are entitled to engage in the outside businesses defined in the partnership documents, which have been signed by each partner.

Partners’ accountability

Some agreements contain the requirement that partners will be just and faithful to each other in transactions relating to the partnership, and shall, when required, explain any transactions to the other partners. Although this provision is fairly vague, it is a useful piece of preventative law. It enables partners to say to each other, 'It's not that we don't trust you, but we need to know what is happening, and we have a right to know under our agreement.'

In a similar vein, it may be useful for partners to have the right to monitor the competence of their fellow partners. Partners are jointly and severally (individually) liable for all of the debts and obligations of the partnership, and the risk of legal action for negligence is a major risk facing architectural practices. Opting for a corporate structure (ie owning and operating the business through a company) rather than a partnership will avoid joint and several liability. However, before deciding on the appropriate legal structure for your business, you should also seek tax, accounting and financial advice.

Partners’ holidays, long-service leave and sabbatical

Some provision should be made for these entitlements even if only to say that partners are entitled to a defined period of annual leave (or more by agreement) at a time which is agreed by the partners.

Hiring and firing

Some agreements provide that partners may not hire and fire without the consent of the others. It is a matter that should be considered when the partnership agreement is drawn. If included, it is suggested that individual partners retain the right to hire in the case of an emergency and fire in the case of gross misconduct.

Amending the partners’ agreement

Agreements can provide that the partners should consider any desirable amendments to the partners' agreement around the time when the general account is drawn up each year, and that alterations are only to be effective if unanimous. This provision could be desirable but is not necessary because the partners can always amend the agreement unanimously at any time they wish.

Professional indemnity insurance

It is in the interest of retiring partners to be covered under the professional indemnity insurance of the continuing firm. However this provision should be treated with care. It is suggested that the provision could be that while the continuing firm has professional indemnity insurance, retiring and retired partners will be included as insureds.

Death of a partner

Provision can be made for:

• Transfer of interest: the requirement that the executors of the deceased transfer his or her interest in the partnership to the remaining partners.
• Means of calculating the amount due: the same considerations apply as for the retirement of a partner (see below).
• Insurance: a ‘buy/sell’ insurance arrangement, where life insurance is taken out in respect of the partners. On the death of a partner, the insurance proceeds are used to fund the buy-out of that partner’s share in the partnership. Such an arrangement could also cover the buy-out of a partner’s share in the case of total and permanent disablement or trauma (where the partners are insured for those events).
• Professional indemnity insurance: where provision is made for insurance of retired partners (run off insurance cover), it should extend to deceased partners while their estates can still be sued for acts or omissions of the partnership (for example, for professional negligence). This differs from state to state and may depend on the type of claim being made.

Prolonged absence through illness or disability

The agreement should provide for after what period of absence the disabled partner's share of profits is reduced and by how much. For example, that for the first six months the partner will receive a full share, for the next six months half a share, and if the absence continues after 12 months, the partner will be deemed to have retired unless the other partners agreed otherwise in writing. Another example is that partners are entitled to a total of one month's sick-leave per year and that sick leave cannot be accumulated from year to year. These are commercial matters to be decided by the partners at the time of formulating the terms of the agreement.

Notice

How notices under this agreement should be served. The usual provision is by pre-paid post to the last known address of the party upon whom it is sought to serve the notice. It is also acceptable to permit notices to be sent by e-mail.

Dispute resolution and deadlocks

It is desirable to include procedures for the resolution of disputes among partners. The objective of these procedures is generally to avoid the parties going to court, or at least to exhaust all other avenues before resorting to legal proceedings to resolve a dispute. For example, the agreement may require the parties to a dispute to mediate before issuing proceedings, and/or to refer a dispute to arbitration. The Australian Disputes Centre and the Resolution Institute each have model clauses which can be included in agreements for that purpose.

To address the possibility of a deadlock arising (for example, because the partners cannot agree on a critical matter or there is a tied vote), it is useful to include provisions designed to break deadlocks. For instance, on the occurrence of a deadlock, any partner could be given the right to offer to buy out the other partners at a specified price, and if the other partners fail to respond, they would be forced to buy out that partner at that price instead.

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Financial considerations

Partnership agreements should always address the financial aspects of the partnership. This includes establishment costs, running costs, partners’ drawings or salaries, distribution of profits, sharing losses and the financial aspects of ending the partnership.

Share of profits

The partnership agreement needs to say in what proportion the partners share in the profits of the business. This may be the same as the proportion of property ownership, but need not be.

If the agreement is being drawn because old partners are retiring and/or new partners are being admitted, it should provide a formula or schedule providing how the shares will alter over a number of years.

Costs and losses

It is usual to provide that costs and losses will be paid out of the gross profits of the business and also to make provision for the proportion to be paid by each partner if there is a deficiency. Common practice is to set the proportions the same as each partner's share of profits.

Banking

Matters taken into account usually include:

• the name and branch of the bank
• that any partner may operate the account – in large firms there might be a provision that more than one signature is required
• that all cash, cheques etc. received on behalf of the business are to be paid into the bank account.

Accounting

The agreement should provide that proper accounts will be kept and that the partners are entitled to examine and copy them any time they wish. It might also provide where the accounts will be stored and who will be responsible for making entries.

Annual accounts

The agreement should provide that a general account will be taken each year as soon as possible after a date which is named in the agreement. In most agreements, the date is the end of the financial year. It should say who will draw the account – usually the firm's accountant or some other public accountant – and that a copy of the account will be given to each partner. The usual requirements are a statement of capital and liabilities, a profit-and-loss statement and a balance sheet. A common provision is that, apart from manifest errors, the partners are bound by the account if no objection is raised within a specified time (for example, three months) of receiving it.

Partnership funds etc

There should be a provision that partnership funds may not be used for non-partnership matters without the consent of the other partners. Similarly, partnership property should not be used as security for loans or other debts without the consent of all partners, and debts should not be released without their consent.

Partners’ drawings

This part of the agreement should say how much money the partners are entitled to receive and when. For example, an agreement can provide that partners can make fortnightly drawings (or otherwise as agreed), taking into account liquid funds and liabilities. Another example is that drawings should, by agreement, be made from time to time. There should also be a provision that if the annual account shows that a partner has overdrawn his or her share, it should be refunded or deducted from future drawings.

Partners’ private debts

Because partnerships, unlike companies, are not legal persons in their own right, the property of the partnership is the property of the individual partners and is therefore at risk of seizure to pay the private debts of the partners. For this reason it is useful to have the provision that partners will pay their own debts promptly and will indemnify the other partners against such private claims.

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Retirement provisions

In addition to dealing with the ongoing nature of a partnership, partnership agreements need to recognise the likelihood of the retirement of one of the partners and should allow for orderly transitions of the interests of the retiring partner.

Voluntary retirement

It is not unusual to require the retiring partner to give substantial notice, such as three or six months. An agreement can provide that, where possible, the notice should expire on the date upon which the general account is taken. This is quite a good idea because it can save considerable time and accounting fees.

Automatic retirement

Age discrimination legislation generally prohibits the forced or automatic retirement of a partner merely because they reach a specified age, although state and Commonwealth legislation appears to permit small partnerships (ie, those with fewer than 5 partners, and fewer than 6 partners under Commonwealth legislation) to have a retirement age for partners, if that is reasonable.

Involuntary retirement

There must be provision either for automatic retirement or for the other partners to give notice of retirement in the case of misconduct or incapacity. Reasons include where a partner:

• is bankrupt
• commits an act of bankruptcy
• wilfully or persistently breaches the partnership agreement
• ceases to be a registered architect
• commits a criminal offence that is more than trivial
• does something that would be grounds for dissolution of the partnership by a court
• engages in conduct so that the other partners can't do business with the partner.

Consultancy work

If it is desired that voluntarily retiring partners should be available for consultancy work, the agreement should say so and provide for the remuneration that will be received.

Retired partners not to compete

As long as the provision is not too sweeping, retiring partners can be bound not to poach the clients and employees of the firm for a defined period of years (usually two or three) and not to compete with the firm in a defined geographic area (usually, no broader than where the partnership operates) for a defined time (again, usually a few years).

Calculation of the amount owing to the retiring partner

The agreement should establish a means to work out the amount to be paid to the retiring partner, and should provide when it will be paid. If the partnership owns substantial assets, the remaining partner(s) are unlikely to be able to pay the retiring partner immediately and it might be wise to provide that payments will be made by defined instalments.

The agreement should state:

• how profit and loss is calculated up to the date of retirement
• whether unbilled work is included
• whether goodwill is included – where the retirement is involuntary it is sometimes not.

Agreements can contain a formula for calculating goodwill based on the partner's length of service and the average profit for the previous two years. As the true value of architects' goodwill is difficult if not impossible to calculate, this is a good idea if goodwill is to be included.

Note: The question of whether goodwill is to be included should be discussed with an accountant. At the date of this note, the inclusion of goodwill in a partnership agreement can lead to a substantial accrual of tax every time a partner is admitted or leaves.

Payments

Partners who do not settle their accounts immediately with an outgoing partner may pay a high price in cases where there are no written partnership agreements, or where agreements are inadequate. That is because in those circumstances, under section 46 of the Victorian Partnership Act 1958 and other state equivalents, the retiring partner or his or her estate has the option of claiming an entitlement to such share of the profits of the partnership made since his or her retirement as a court may find attributable to the use of the retiring partner’s share of the partnership assets, or to interest on his or her share of the partnership assets (the interest rate is 7% per annum in Victoria).

Therefore, a retiring partner needs to consider the future profitability of the firm. Faced with partners who refuse to pay a share of partnership assets, the retiring partner must make a choice. If the firm is only marginally profitable, under section 46 or its equivalent, it may be best to take an interest payment calculated on the share of partnership assets. If the firm is profitable, it may be best to pursue a share of partnership profits.

The obligation to pay a retired partner’s share continues until the share is paid out. The continuing partners of a profitable firm should avoid protracted negotiations and pay the retiring partner’s entitlement to partnership assets without delay.

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