There are many misconceptions about what happens when someone gives notice to leave a partnership.
Often, the other partners want to ‘continue’ the partnership, and they will immediately begin to treat the departing partner as an ‘outsider’. While this may feel correct to the continuing partners, this is not how the law sees things. Read on to find out what your rights and obligations are, whether you are the person walking out the door, or one of those staying behind…
What law governs partnerships?
Partnerships are governed by a number of different laws.
Fundamentally, a partnership is a creature of contract law. This means that the parties to a partnership can agree how the partnership will be regulated, including what happens when someone leaves. When you have any questions about your partnership, your Partnership Agreement should be the first place you look.
However, these general contractual principles have been supplemented by principles of ‘equity’ (e.g. fiduciary obligations and a duty of good faith) as well as legislation (such as the various state ‘Partnership Acts’ in each State)1. For partnerships without a valid Partnership Agreement, these laws will govern how your partnership operates.
When does a partnership come to an end?
A number of things can trigger the end of a partnership, namely:
- The expiry of an agreed fixed term, if the partners only intended on staying together for an agreed period of time;
- The ending of the agreed ‘activity’ the partnership was going to carry on, e.g. if it was set up for a specific purpose of project;
- The activities of the partnership becoming illegal;
- A partner becoming bankrupt or dying;
- The court dissolving the partnership due to a partner’s mental incapacity; or
- A partner giving notice they wish to leave.2
Importantly, a partnership comes to an end whenever there is a change in the people (or entities) making up the partnership. So, for example, if a new partner joins a partnership or an old partner leaves a partnership, the ‘original partnership’ ends and a ‘new partnership’ is formed. This clear delineation is significant because it marks when a number of important legal concepts begin and end (e.g. when a partner’s fiduciary obligations and ‘joint and several liability’ begin and end).
The general proposition that a partnership ‘ends’ on a change in partners can be modified by agreement between all the partners. The partners can agree (before the dissolution) that the partnership will effectively continue when someone leaves. However, so far as the legal rights and obligations of the partners is concerned, a partner’s retirement still effectively ends the ‘original partnership’.
The partners can agree in their Partnership Agreement how the departing partner will be treated, and how the continuing partners will continue the partnership. For example, the partners could agree that a departing partner will get some cash, and the new partners will continue the partnership with all of the partnership assets. It may set out how the amount of cash is determined, when it must be paid, and may even restrain the departing partner from competing with the continuing partnership. However, all of these terms must be agreed between ALL of the partners prior to the partner leaving. The ‘continuing partners’ cannot impose these sort of conditions on a partner after they have elected to leave.
The reason these rules are binding on the departing partner and the continuing partners is because all the partners agreed to these terms before anything happened.
However, in the absence of a clear agreement before someone leaves (i.e. without a Partnership Agreement that deals with these issues), when a partner leaves a line in the sand is drawn and the continuing partners will only be able to continue the partnership with the consent of the departing partner. If agreement cannot be reached, then the partnership is dissolved, and all partners then have an equal right to all the partnership assets and remain equally responsible for all the partnership obligations.
Can a majority of partners ‘expel’ a partner?
While it is possible for a partner to dissolve the partnership by giving notice to the other partners, it is not possible for a majority of partners to expel a partner, unless they have explicit authority to do this in the Partnership Agreement. For example, in South Australia, section 253 states:
No majority of the partners can expel any partner unless a power to do so has been conferred by express agreement between the partners.
What this means is that any partner can bring a partnership to an end, but a majority of partners cannot get rid of a partner and simply continue the partnership. This ties in with the rule that all partners have an equal right to all the partnership’s assets (unless otherwise agreed).
This is another reason to have a carefully drafted Partnership Agreement that gives a majority the right to expel a partner and records how this will take place, i.e. when and on what terms the expelled partner must leave.
What rights do partners have when someone leaves?
On the dissolution of the ‘original partnership’, each of the partners in the original partnership have the same rights and obligations. The people in the original partnership remain responsible for the obligations of the original partnership4 and remain entitled to share in the surplus assets of the original partnership5, in each case in proportion to their interest in the original partnership.
Further, each partner retains authority to act on behalf of the original partnership to wind it up.6
It may be that some of the partners form a ‘new partnership’ (which may effectively be a continuation of the original partnership). From a legal perspective, this is completely separate from the original partnership. The terms of any new partnership do not confer any special rights on the people making up the new partnership. They also do not take away any rights or obligations of the partners in the original partnership.7
The partners in the original partnership may agree to vary these rights and responsibilities, but they are not obliged to.8
Who owns the assets of the original partnership?
If a partner in the original partnership takes assets of that partnership exclusively for themselves, they must account to all the partners in the original partnership for the value of what they take. This does not mean that any partner can simply take what they want and pay the other partners. If the other partners object to this, then they may apply to court for a return of the assets, followed by an equal division among the partners or a disposal to a third party.
It is quite common for only one partner to leave a partnership, and for the remaining partners to want to continue the business previously carried on by the original partnership using the assets of the original partnership (including any IP or goodwill). However, just because a majority of the partners wish to continue the business does not mean they have exclusive rights to the assets of the original partnership.9
The partner who has left retains all their interest in the assets of the original partnership until they agree otherwise. They also remain jointly and severally liable for all the obligations of the original partnership.
These principles apply to all partnership assets and liabilities. This includes the tangible assets of the partnership (e.g. equipment, furniture and stock) as well as the intangible assets (e.g. work-in-progress, debtors, leases, IP, goodwill and contracts).
It may be that the partners agree that some of the partners will keep certain identified assets, but this must be agreed by all partners. In the absence of agreement, all partners are entitled to a proportional share of the partnership assets.
What should you do?
The bottom line is that you should always have a written Partnership Agreement which clearly records how partners can come and go. This will facilitate an orderly transition from your ‘original partnership’ to any ‘new partnership’ when someone leaves (or joins).
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1 In South Australia, partnerships are governed by the Partnership Act 1891 (SA). Each state in Australia has a partnership Act, but we have used the South Australian Act for the purposes of illustrating these principles.
2 Section 26(1) of the Partnership Act 1891 (SA) states that a partner can dissolve a partnership by giving notice to the other partners: “Where no fixed term has been agreed upon for the duration of the partnership, any partner may determine the partnership at any time on giving notice of the partner’s intention so to do to all the other partners.” This is mentioned again in section 32(c): “Subject to any agreement between the partners, a partnership is dissolved, if entered into for an undefined time, by any partner giving notice to the other or others of the partner’s intention to dissolve the partnership.”
3 Partnership Act 1891 (SA).
4 Sections 9 to 14 of the Partnership Act 1891 (SA).
5 Section 39 of the Partnership Act 1891 (SA) states: “On the dissolution of a partnership every partner is entitled, as against the other partners in the firm, and all persons claiming through them in respect of their interests as partners, to have the property of the partnership applied in payment of the debts and liabilities of the firm, and to have the surplus assets after such payment applied in payment of what may be due to the partners respectively after deducting what may be due from them as partners to the firm; and for that purpose any partner or his or her representatives may on the termination of the partnership apply to the Court to wind up the business and affairs of the firm.”
6 Section 38(1) states: “Subject to this section, after the dissolution of a partnership the authority of each partner to bind the firm, and the other rights and obligations of the partners, continue, notwithstanding the dissolution, so far as may be necessary to wind up the affairs of the partnership, and to complete transactions begun but unfinished at the time of the dissolution, but not otherwise.”
7 Section 17(3) of the Partnership Act 1891 (SA).
8 Section 19 of the Partnership Act 1891 (SA).
9 Section 20(1) of the Partnership Act 1891 (SA) states: “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.”