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Published: Fri, 02 Feb 2018
Existence of a partnership criticized
Partnership Act 1890 (“the Act”) is constantly being criticized as of advanced age and thus fails to suit the vast number of modern partnerships. Yet, it is also suggested that it is vagueness in the Act, rendering it high degree of flexibility and adaptation, accounts for its continued survival. So is the Act under need for reform? While it might be true that vagueness in the Act allows it to be flexible, this paper will reveal that its usefulness is in doubt. Nevertheless, it is beyond the scope of this paper to discuss all possible flaws and indeed this paper will focus on specific provisions under the Act.
Existence of a partnership
Carrying on a business
A partnership is the relationship which exists between persons carrying on a business with a view to profit. The relationship is determined by the substance of the interaction and not by the wishes of the parties. There are three elements for a partnership to be established, namely, “the carrying on of a business”, “in common” and “with a view to profit”, missing any one of which there cannot be a partnership. Yet these features are not always easy to be identified and very often it would be left as a matter of construction for the court. Dignam and Lowry suggested that the confusion in the area as to what behavior amounts to a partnership causes many problems.
The board phrase “carrying on a business” has received much attention by the courts as to what exact behaviour amounts to “carrying on a business”. Basically, the existence of a mere agreement to set up a partnership without further implementation does not give rise to a partnership. There has to be the carrying on of some business activities by the person involved. Thus, there is a distinction in the law of partnership between contemplated and actual partnerships. The definition of this term has given rise to problems created by modernization.
In Miah v Khan, the House of Lords rejected the Court of Appeal’s conclusion that there was a rule of law that the parties to a joint venture do not become partners until actual trading commences. This is a reasonable decision as it would, otherwise, eradicate any preparatory behavior which could be considered as to create a partnership. Instead, Lord Millett suggested, in his sole judgment, that the persons involved became partners “until they actually embark upon the activity in question” and the test was whether the parties had done enough to commence the joint enterprise they agreed upon. By that, any commercial activity can be carried on by a partnership.
While the House of Lords had attempted to clarify the situation, it remains hard to decide whether acts done by the persons involved are merely preparatory in carrying on a business or are regarded as business activities. In Miah v Khan, the opening of a joint bank account, obtaining of a bank loan, acquiring premises, furniture and equipment, making a contract for the laundry and advertising the restaurant in the press were considered to be business activities. Whereas in Gouberg v Herniman, it was held that there was no carrying on of a business even though acts like doing market research, making demographic studies and travelling twice in order to run the business were done. Similarly in Blue Line Hockey case, the agreement between parties to hold exploratory talks, to acquire a hockey team and the making of interests to the vendor were not enough to amount to carrying on a business.
The Act’s vagueness in this area can be particularly fatal in today’s business which often consists of different stages with considerable time and expenses involved. Moreover, why cannot acts done in the preparatory stages give rise to a partnership? It might be the intention of the parties to be acting as partners even in the preparatory stages. The fact that there has to be some business carried on to establish a partnership ignored the relevancy of any act which occurs before the business exists and is arguably unrealistic in today’s business world. “Partners” will very often take part in complex agreements, preparations and dealings before actual business can be said to take place and the law in this area would obviously ignore those who invest in the business. Moreover, if partnership cannot exist before the commencement of business, what capacities are those persons involved acting as? At this point, it is worth mentioning Lord Buxton’s dissenting judgment in Khan v Miah where he suggested that relationships of agency if not trust existed between the parties. The consequence of such relationships is that there has to be separate litigation for each single transaction that arises between disputing parties. This cannot be the purpose of partnership law which should be intended to make matters arising between persons acting in a commercial venture easier. Travis suggested that the mark should move backwards to “the first commercial activity undertaken” which not only excludes personal activities but removes the restriction to commencement of a business.
Although it has to be admitted that the lack of formality in determining the existence of a partnership under the Act renders it flexibility, it is arguable that it requires more certainty in the area for those persons involved. They have to know what exactly done by them can give rise to a partnership in law and what does not. This is of vital importance especially when the courts are observed to be generous to find the existence of a partnership. After all, the Act could potentially include “virtually any activity or venture of a commercial nature, including a “one off” trading venture” as a business.
Carried on in common
It seems there must be joint participation but not mere co-operation in the common business for there to be a partnership. Joint participation in a business can even give rise to a partnership without an agreement being drawn up. The law here is somewhat confusing as it suggested that an intentionally drafted and signed agreement might not necessarily give rise to a partnership while mere participation can.
This can also be conflicting within the Act itself. On the one hand, degrees of participation are not relevant in allocating profits but it is of relevance when considering the existence of a partnership in terms of carrying on a business in common.
Rules for determining existence of partnerships
The rules in s2 of the Act are intended to be useful indicators in determining the existence of a partnership. However it should be noted that these rules are set out in the negative, i.e. listing out those which are not considered to be a partnership, instead of the positive. Although it should be agreed that it will not be conclusive even to set out these rules in the positive, it should at least provides more grounds in determining which kind of behavior could create a partnership. The absence of such a list prevents both the parties and the courts from referring to as a list of guidance.
Some argued that the design of s2 is intentional as it allows the courts to take a factual approach to each case and remain unfettered. Yet, the inclusion of a positive list should not be seen as a restriction to the court’s freedom in the area as the guidelines should not be at all exhaustive.
Among the different rules in s2, s2(3) is the most important where it states that a receipt of the profit in the business does not itself make the person a partner of the business but is prima facie that he is a partner of the business. The wordings are contradictory at first glance where the receipt of profits can be prima facie evidence to find a partnership in the absence of other evidence, mere receipt of profits alone cannot in itself make the recipient a partner. Despite the confusing words used, s2(3) is believed to mean that the court has to find a partnership if the receipt of profits is the only evidence. In reality, the court has always found other relevant evidences to consider and if so, the assistance of s2(3) would be minimal. Thus, the usefulness of s2(3) is clearly in doubt as shown by case laws and the Law commission has even suggested that the whole s2 be repealed from the Act.
Provisions on Dissolution
It is suggested that some problems caused by the Act are due to the fact that it lacks a separate legal personality where the partnership is an entity with its own rights and obligations separate and distinct from the members. The statement has some grounds at least in relation to the dissolution of a partnership under the Act. Under s26(1), a partner can dissolve a partnership with no fixed term agreed upon by giving notice. This means other members cannot continue the business after one member resigns. In Scotland, where partnership has a legal personality, it was suggested that a partnership can continue even after any member resigns. On the other hand, there is similar provision under s32(c) which provides for the dissolution of a partnership with an undefined time by notice. The terminologies of “no fixed term” and “undefined time” have caused some confusion although s32(c) is subject to contrary intention. The court in Moss v Elphick tried to clarify the situation by suggesting that s26 could only apply when the agreement does not specify the duration of a partnership which necessarily means it does not include any provision on termination, whereas s32(c) could only apply whenever there is no contrary intention. Thus, any provision in the agreement on termination would not make it of “no fixed term” and effectively provides for a contrary intention which prevents both sections from applying. The distinction made by the court on the two sections is somewhat artificial as it is hard to rationalize the interpretations by simply referring to the wordings alone. If partnership has a separate legal personality, potential conflicts between the two sections might be prevented.
S33 and s34 of the Act similarly provide for dissolution of a partnership not on resignation but on the death, bankruptcy or illegality of a member. The consequences of such provisions are hard to understand in reality as these would lead to many unnecessary terminations of partnerships even if contrary to the wishes of the remaining partners who are willing and able to carry on the business.
While it is argued that one of the reasons for dissolution of a partnership on a member’s leaving is because the partnership being a contract between all the members of a partnership has changed, it could also be argued be that it is only the contract between the withdrawing partner and the partnership ceases. Indeed, Lord Millett had suggested in Hurst v Byrk that a partnership is more than simply a contract by that it is both a continuing personal and commercial relationship. Thus, the law governing partnerships should not only look into contractual matters but also commercial realities.
Moreover, although these sections on dissolution protect the interest of withdrawing partner by ensuring them to get their own share out of the assets of the partnership, they ignore the interests of the remaining partners and the partnership as a whole. Arguably, this imbalance is contrary to commercial reality and the need for the partnership to start again is also troublesome and unnecessary. The Act’s failure to give options to the remaining partners as to whether to buy out the withdrawing partner’s share or break up the partnership is unfortunate.
Liability of partner
Under the Act, there is no separate legal personality for partnerships where members can have limited liability. S9 of the Act provides that partners remain jointly liable to debts and obligations of the partnershipalthough strictly specking the liability is joint and several under Civil Liability (Contribution) Act so far as civil liability is concerned. All partners have unlimited liability for the partnership’s debts and obligations. Thus if there is any member who misbehaves and incurs debts of the partnership, the innocent partner will not only lose his investment but also his personal property to repay the partnership’s debts. This is not an attractive feature of partnership as it makes the risk in entering a partnership with another large.
It is argued that unlimited liability of partners acts as a safeguard to ensure that no member remains free of liability, which is the case when the protection of a corporate veil is available under company law. The argument is indeed week in view of the current company law, which allows the court to lift the veil whenever necessary.
Granting partnerships separate legal personality is strongly proposed by the Law Commission and it is suggested that this should not be ignored any further. Moreover, the way that the courts dealt with separate legal personality in company law should give confidence that any abuse of the system would be minimal and it works effectively.
The Act has governed the law of partnerships for over 100 years, and it applied to partnerships which were small in size at the time of its enactment. Partnerships nowadays usually have partners ranging from two to many hundreds and it is arguable that the Act cannot meet the expectation of these large partnerships. Yet, the need to reform is not simply based on modernization. Problems caused by the vagueness of the Act should value concern especially in the rising number and expectation of modern partnerships today. It is high time to balance flexibility and certainty of the Act. Although most of the problems posed by the Act can be solved by drafting a partnership agreement which allows each specific partnership to create its own provisions, it has to be reminded there are partnerships which arise either verbally or informally which makes application of the Act possible. Moreover, reform of the Act might cause partnerships to rely more on it and make the absence of a partnership agreement less detrimental. It is also true that application of the Act is now accompanied by bulk of case laws and it should be high time to codify these decisions into the law.
Although this paper cannot address every single problem caused by the Act and cannot go through every possible reform as it would be beyond the scope of this paper, it is evident from the analysis here that the existing Act is clearly problematic and in need of reform. It is hoped that a more certain and consistent law governing partnerships is to be in place in the very near future.
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