Partnerships: Retiring Partners and Avoiding the Pitfalls

A recent decision by the Court of Appeal in relation to a long-running family farming dispute has shone a spotlight on the importance for partnerships to have clear and appropriate rules governing a partner’s retirement from its business.

The dispute (Proctor v Proctor)

The case centred on the voluntary retirement by notice, in 2010, of a partner in a family farming and property partnership business, which was accepted by the remaining partners, who then continued to carry on the partnership business themselves. However, the outgoing partner and the continuing partners did not agree any terms in respect of the outgoing partner’s interest in the partnership, and neither the partnership agreement between the partners, nor the Partnership Act 1890 (PA), made any allowance for this.

The outgoing partner subsequently made claim to a proportionate share of the partnership’s assets and income. The continuing partners resisted, arguing that, as there was no express provision in the partnership agreement or the PA, nor had any other agreement been reached between them relating to the outgoing partner’s entitlement to any share in the partnership business on retirement, the outgoing partner had no right to any share in the partnership’s assets.

The Court’s decision

The Court ruled that, whenever there is a change in the composition of a partnership (for example, through retirement, or appointment, of a partner), there is a “technical dissolution” of the partnership in the sense that the contractual relationship between the partners change as a result of the change in identity of the partners. But, it said, this should not be confused with a “general dissolution” of a partnership, which would require the partnership’s assets to be sold and distributed between the partners.

In Proctor, there was no express provision in the partnership agreement, and there had been no other arrangement made between the partners, in relation to the retiring partner’s share in the business.  In retiring the way she did, the outgoing partner, gave up her right to a general dissolution and winding-up of the partnership, but did not give up her entitlement to:

• a share in the partnership’s profits attributable to the use of her share of the partnership’s assets by the continuing partners following her retirement (as provided for in section 42 PA); or

• her interest in the partnership’s assets at a fair market valuation (and not book value) that would have been achieved had there been a general dissolution and winding-up of the partnership.

Practical implications

Unless explicit provisions are agreed to the contrary, if the remaining partners of a partnership continue to use an outgoing partner’s interest in the assets of the partnership in carrying on the partnership business, they must account to the outgoing partner for the value of that interest, both in terms of profits generated by it, and the amount that the outgoing partner would have received for it if the business had been wound up.

This could very well place continuing partners under potentially onerous and burdensome obligations to meet an outgoing partner’s financial entitlement, and raise difficult issues for the survival of a partnership (especially where the partnership is asset-rich, but cash-poor).

The case underlines the need for sound legal advice when preparing a partnership agreement to ensure there are prescriptive arrangements setting out the circumstances that permit, the procedure for, and the entitlements that arise on, the retirement of partners.

For further information about this, please contact Corporate and Commercial Solicitor Nick Mayles.  Nick is a highly experienced transactional corporate and commercial lawyer.  If we can assist with any questions you may have in relation to your business, please get in touch by emailing nick.mayles@tsplegal.com or call 01206 574431.