An overview of partnerships in Australia
/When people make the decision to go into business together, one important yet often overlooked consideration is how best to establish the legal relationship between them.
There are various types of legal relationships that can be created to establish the ownership, operation and liabilities associated with a business.
One of the most common forms of business relationship is a partnership. A partnership is a relationship that exists between two or more “persons” carrying on a business in common with a view to profit. The relevant legislation which governs partnerships is the Partnership Act 1895 (“Act”).
For the purposes of a partnership, a “person” can include any one of the following:
individuals;
companies;
trustees of trusts;
other partnerships; and
associations (subject to specific exceptions).
There are three common types of partnerships, namely:
General partnership – where each partner has an unlimited liability for the debts and obligations incurred by the partnership business;
Limited partnership – where each partner’s liability is limited to the amount of money they have contributed to the partnership; and
Incorporated limited partnership – where partners can have limited liability for the debts and obligations of the partnership business, provided that there is at least one general partner with unlimited liability.
This article will focus on the general partnership. It will provide a summary of the advantages and disadvantages of choosing a general partnership, and finish with some some general observations to assist individuals in considering whether or not a partnership is right for them.
Advantages of a partnership
Sharing of resources
One of the key benefits of a partnership business is that it allows the partners to pool their respective skills and resources (skilled labour, financial resources, equipment etc).
For example, a partnership between a small exploration company with specific technical expertise and a large mining company with significant available funds may be mutually beneficial in that the large company can provide the necessary funding to allow the small company to utilise its specific skills and technology to carry out exploration activities that may result in an outcome that would have been unachievable by either company on its own.
Cost effective to establish
The costs associated with establishing a partnership are relatively low when compared with other relationships.
In order to establish a partnership, the partners simply need to register a business name and obtain an Australian Business Number and Tax File Number. The partnership will also need to register for GST if the annual turnover equals or exceeds $75,000.
It is common for a partnership to be brought into existence by way of a written partnership agreement. While a written partnership agreement is not required, it is in almost all cases preferable to have an agreement that sets out the parameters of the relationship more clearly to minimise the risk of future disputes between partners.
Tax offsets
A partner can offset losses of the partnership against their income from other sources. This is because a partnership is not a separate legal entity, but rather a business relationship between the partners.
Disadvantages of a Partnership
Liability for partnership debts
Section 16 of the Act prescribes that every partner in a firm[1] is liable, jointly with the other partners, for all debts and obligations of the firm while he is a partner.
As noted above, a partnership is not a legal entity, therefore it is the partners who assume personal liability for partnership debts. The liability is not apportioned according to each partner’s ownership share of the partnership. Instead, each partner has an unlimited liability for partnership debts. How the debts are apportioned between the partners is a matter for the partners to agree upon.
The implications of section 16 are significant, particularly in the case of individual partners. In effect, the partners each have an unlimited liability for partnership debts owing to third parties. In addition, there is an ongoing risk of a breakdown in the relationship between partners, which may lead to one or more partners refusing to contribute to repayment of the debts.
Liability for partnership wrongdoings
Pursuant to section 19 of the Act, every partner is jointly and severally liable with his co-partners for the firm’s wrongdoings under section 18 and 19 of the Act.
Partners therefore face an additional ongoing risk of exposure to liability for a myriad of wrongdoings of their co-partners, including misappropriation of partnership funds. This liability will arise notwithstanding the fact that a partner may have had no involvement in or knowledge of the wrongdoing.
Difficulty of changing membership
The process for changing the ownership of a partnership is difficult and in many cases will require the dissolution of the current partnership and establishment of a new partnership. This is distinct from other relationships such as a limited liability corporation where the process for adding and removing shareholders and directors is relatively straightforward.
General observations
It is becoming increasingly common for people to form limited liability corporations to run a business in favour of partnerships. The primary reason is so that the individuals are not exposed to the risk of an unlimited liability for conduct of other partners on behalf of the partnership.
An unfortunate reality of partnerships is that relationships between the partners may break down over time, which can result in unintended and potentially devastating outcomes for the partners as a result of their unlimited liability for partnership debts.
A frequently occurring example is debts to third parties that go unpaid after a breakdown of the relationship between the partners. Those debts remain owing after the dissolution of the partnership, and in some cases may accrue significant interest and penalties. If the debt remains unpaid, Court proceedings may be commenced against one or more of the partners personally.
Prospective partners would be well advised to think carefully about the implications of forming a partnership and give due consideration to whether the persons that they are intending to go into partnership with are persons that they can wholly trust.
If you would like more specific advice in relation to whether or not a partnership is the right business arrangement for you, we recommend you contact Edwards Mac Scovell.
[1] Section 10 of the Act contains a definition of “firm”: “Persons who have entered into a partnership with one another are, for the purposes of this Act, called collectively a firm, and the name under which their business is carried on is called the firm-name.”