The Mechanics of a Partnership Claim
1. There are two types of partnership claim. Where there is a partnership agreement which contains an option to purchase the interest of the departing partner, the claim will involve the determination of whether that option has been exercised validly and (if so) what sum is payable to the departing partner. Normal contractual principles apply to such a claim. In particular, the sum to be paid to the outgoing partner (and when this sum is payable) is determined under unusual principles of construction without consideration of what that departing partner would receive on winding-up (see Drake v Harvey [2011] EWCA Civ 838; Liddle v Liddle [2019] EWCA Civ 346). The other type of partnership claim involves winding-up with the assistance of the Court. This seminar deals with the mechanics of the latter type of claim.
2. Disputes in partnership actions can conveniently be divided into six areas, being as follows:
1) Issues relating to the period to dissolution, that is to say fundamental disputes as to the identity of the partners, the terms of the partnership and the identification of partnership assets
2) Death, retirement and expulsion from joint lives partnerships and the consequences of the same. The winding-up of joint lives partnerships by the Court.
3) How the assets are to be sold or otherwise distributed following dissolution
4) The determination of who is to manage the business of the partnership until it can be sold
5) Section 42 accounts
6) Litigation issues.
1) ISSUES RELATING TO THE PERIOD TO DISSOLUTION
3. The Court will not interfere in the operation of a partnership save with a view to its dissolution. In this context, “dissolution” is a full dissolution involving the termination of the partnership and the sale of assets rather than a technical dissolution which occurs on any change in the membership of a partnership. A partnership claim necessarily involves the taking of at least a dissolution account following the determination of all issues which are required before that account can be directed. If not agreed, the Court will need to determine:
1) Whether there is a partnership at all and (if so) whether any written partnership agreement applies.
2) Profit shares
3) Ownership of partnership assets
4) Normal accounting issues
5) Additional accounts
1) Terms of the partnership
4. Where there is a written partnership agreement between the current partners, this will determine the terms of the partnership. However, this is rarely the case. Usually, any partnership agreement will have been made many years ago between the original partners. The Court will need to determine whether new partners have adopted the partnership agreement. If not, there will be a partnership at will. A partnership agreement cannot operate between some but not all of the partners. This issue is of particular importance if the partnership agreement contains an option to purchase.
2) Profit shares
5. This is only likely to be an issue in relation to a period not covered by agreed accounts.
3) Ownership of partnership assets
6. It is difficult to dissociate the ownership of land and other assets used by a partnership from the way in which the capital accounts of the partners have been treated.
7. In the context of partnership law, “capital” is a sum of money which is invested by a partner in the business of the partnership on the basis that the same is not to be returned until dissolution (or ceasing to be a partner in a joint lives partnership). An “advance” is a sum of money which is loaned to the partnership which is expected to be repaid. At least as a matter of law the two are different and such difference is accepted by the order of priority of payments set out in section 44 of the Act.
8. Capital profits arise from the sale of a partnership asset. Capital profits follow income profits save where the contrary is agreed expressly (which would be rare) The value of any asset in the accounts of the partnership is merely an estimate. The value crystalizes on sale. On sale, the value in the accounts is replaced by the sale price and the capital profit which arises is divided between the partners in the capital profit sharing ratios over the period involved. Where there has been a change in profit shares over a number of years, the allocation of capital profits will be difficult.
9. A capital account in its strict sense is merely a statement of the amount of capital introduced by the partners. A current account in its strict sense is an account of what has happened since the partnership has commenced in terms of:
1) Undrawn profits
2) Advances made to the partnership
3) Expenditure incurred by the partnership for individual partners.
In practice, it is rare to find accounts for a partnership which distinguish between capital accounts and current accounts in any way. The only general exception would be farming partnerships. The usual capital account is a combined capital and current account where the total of the capital accounts of the partners equates to the net assets of the partnership. “Capital account” is normally used to refer to this combined account. Accordingly, it is possible (and indeed quite common) to have a negative balance on a partner’s capital account.
10. Section 20(1) of the Partnership Act 1890 (“the Act”) provides as follows:
“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.”
11. Accordingly, partnership property is something distinct from property held:
1) By one partner beneficially
2) By some or all of the partners as beneficial joint tenants
3) By some or all of the partners as beneficial tenants in common
4) Under some other specific trust arrangement.
Partnership property is to be applied for the business of the partnership while trading and, following dissolution, it is available to meet the demands of creditors with the ultimate surplus to be distributed between the partners in accordance with the partnership agreement. No partner has any interest in specie in any partnership property (see Popat v Shonchhatra [1997] CA, 1 WLR 1367).
12. The transfer of land into a partnership necessarily requires the agreement of all partners because the partner who transfers the land into the partnership will require credit for the value of the same as an addition to his capital account. Without such credit, the accounts will not balance in any event. While this agreement can be express or implied (see Miles v Easter [1953] 1 WLR 581, Harman J), an implied agreement is unlikely to arise in the case of land as land can be made available to the partnership in a variety of ways. Section 20(1) of the Act is in effect a conveyancing section (see Wild v Wild [2018] EWHC 2197 (Ch) HHJ Eyre, KC). There needs to be an agreement to bring the land into the partnership and section 20(1) of the Act avoids the need to comply with section 2 of the Law of Property (Miscellaneous Provisions) 1989.
13. The fact that the interest of a partner is reflected in his capital account means that a partner’s capital account can be considered to be an interest in property in its own right. Thus, capital accounts can be held as joint tenants and can pass by survivorship. This principle was accepted by the Court of Appeal in Hopper v Hopper [2008] EWCA Civ 1417 where the only issue between the parties was as to whether there was a joint capital account between father and mother, with children having separate capital accounts or whether there was a single joint capital account. A joint capital account obviates the need for a dissolution account. The Court might not be prepared to accept that a joint capital account has been created by agreement without the evidence of the partnership accountant.
14. In determining whether an asset is partnership property, the fundamental questions to be addressed are:
1) Whether there is any declaration of trust
2) When it was purchased.
15. Where there is an express declaration of the trusts on which land is to be held then this will generally determine the beneficial interest of the parties (see Pettitt v Pettitt [1970] AC 777). This principle applies to land used by a partnership. A transfer of land to a partnership ought to contain an express declaration of trust that the land is held by the transferees as partners or as a partnership asset or upon the trusts of the partnership. An express declaration of trust that land is to be held by persons who are partners as tenants in common is not inconsistent with its being partnership property (see Megarry & Wade, The Law of Real Property, 8th Edition, paragraph 13-029). However, an express declaration of trust that land is to be held them as joint tenants is inconsistent with its being held as partnership property (see Barton v Morris). The treatment of land held by partners as joint tenants as partnership property in the accounts of a partnership will not amount to severance.
16. Section 21of the Act provides as follows:
“Unless the contrary intention appears, property bought with money belonging to the firm is deemed to have been bought on account of the firm”
The effect of this provision is that where it is possible to show that an asset was bought during the partnership it will be a partnership asset unless there has been a conscious effort to ensure that funds were taken out as drawings and then applied in the purchase.
17. An agreement to transfer partnership land has to comply with section 2 of the Law of Property (Miscellaneous Provisions) Act 1989. This is particularly important for dissolution agreements.
4) Normal accounting issues
18. Partnership claims are usually allocated to the Business and Property Court as this has BPC District Judges who have experience of directing the accounts. In practice, it makes little difference whether the claim is heard in the Property, Trusts and Probate List or the Business List. The Court does not produce accounts. Its role is limited to:
1) Directing a party to produce accounts;
2) Directing how the other party is to object to (falsify) the same.
3) Directing how the issues are to be determined.
4) Determining issues
5) Directing the production of adjusted accounts based on those determinations.
19. Normal issues on accounts would include whether particular expenditure was properly incurred or reasonable or whether a partner had a right of reimbursement. The accounts must be full. A partner cannot ask the Court to deal with one part of the account and leave the rest unresolved (see Green v Hertzog [1954] 1 WLR 1309 as approved in Hurst v Bryk [2002] 1 AC 185). The accounting process normally starts from the last set of agreed accounts and ends at dissolution. Particular issues arise when a partner seeks to challenge previously agreed accounts. This can only be done if there is fraud or manifest error.
5) Additional accounts
20. Although a full account is required, there is no reason why the claim should be limited to this. The claim could include debts owed by one partner to another outside the partnership and debts owed to the partnership by third parties. Third party debts are joint and so all partners need to be before the Court. However, there is no rule that all partners have to agree to pursue a claim against a third party (see Banks v Turner 20th February 2018, HHJ Klein)
21. Claims between partners may lead to the taking of non-standard accounts. If one partner claims that the other has misappropriated customers, then there can be an account in relation to this issue. It is not part of normal accounting and it will be necessary to determine whether this additional account should be taken first.
2) JOINT LIVES PARTNERSHIPS
22. A partnership at will can be dissolved on notice. There is no need for this period to be reasonable. As regards the outgoing partner, a joint lives partnership will end on death, notice or expulsion. The Court also has power to dissolve if there is no other alternative.
23. An expulsion clause is never implied (see section 25 of the Act). A joint lives partnership agreement should contain an express expulsion clause because it will otherwise be impossible to remove a partner who is in flagrant breach of the agreement otherwise than by asking the Court to dissolve the partnership. A repudiatory breach of the partnership agreement by a member does not enable the other members to treat the partnership as being at an end (see Hurst v Bryk).
24. In order to expel a partner, there must be strict compliance with the terms of the expulsion clause. In addition, the power to expel must be exercised bona fide and not for an ulterior purpose. In contrast with club law, no term that there should be compliance with the rules of natural justice is implied. The most that is implied is that the partner receiving the notice of expulsion should be able to give an explanation for his behavior. Even as regards the implication of such a term, there attitude of the Court has been mixed. Certainly, it would be wise for the partners making use of the power to expel to allow the partner to be expelled an opportunity to explain himself because this will assist in showing that they are acting in good faith.
25. Under section 35 of the Act, the Court has power to order the dissolution of any partnership (including a joint lives partnership) in the following circumstances:
1) When a partner, other than the partner suing, becomes in any way permanently incapable of performing his part of the partnership contract (sub-section (b))
2) When a partner, other than the partner suing, has been guilty of such conduct as, in the opinion of the court, regard being had to the nature of the business, is calculated to prejudicially affect the carrying on of the business (sub-section (c))
3) When a partner, other than the partner suing, willfully or persistently commits a breach of the partnership agreement, or otherwise so conducts himself in matters relating to the partnership business that it is not reasonably practicable for the other partners or partner to carry on business in partnership with him (sub-section (d))
4) When the business of the partnership can only be carried on at a loss (sub-section (e) and
5) Whenever in any case circumstances have arisen which, in the opinion of the court, render it just and equitable that the partnership be dissolved (sub-section (f).
26. Of these grounds, that provided by section 35(f) arises most frequently. Although the Court may refuse to grant dissolution where the applicant for the order is the partner who is responsible for the breakdown in mutual trust and confidence, the difficulty faced by the Court in refusing to make an order is that it cannot force people to work together.
3) HOW THE ASSETS ARE TO BE SOLD FOLLOWING DISSOLUTION
27. Following dissolution the Court has the power to order the sale of all of the assets of the partnership (including land) and will usually do so because to do otherwise would or might deprive the former partners from realizing the maximum return from the assets of the partnership. The practice is only departed from in two situations, namely (i) when a Syers v Syers Order is made and (ii) where the sale of the partnership assets would offend statute or would otherwise be difficult to achieve
28. It follows that in many cases it will be obvious that there will need to be a sale of the assets of the partnership and that the winding-up of the partnership cannot commence in proper without such sale. Unless there is some good reason why a sale would not be ordered at the trial of the claim, there is no good reason to delay a sale until such time. For example, if the issue between the partners is whether the profits are to be shared equally or one third two thirds, there is no good reason why the sale should be delayed until the trial. Obviously, of there is an issue as to whether a particular asset is a partnership asset, the sale will not be ordered until this issue has been determined.
29. In principle, there is little difference between the conduct of the sale of partnership assets and a sale of co-owned assets. Any partner will be allowed to bid and the likelihood that a particular partner may bid will affect which who has conduct of the sale. A partner cannot bid and have conduct of the sale. The only concern of the Court is that the assets of the partnership should be sold at the best price reasonably obtainable in the circumstances. It is common for one partner to be given conduct of the sale on the basis that he will sell at or above a particular price provided that his agent considers that the price is the best price reasonably obtainable in the circumstances (which is a deliberately vague expression).
30. It would be normal practice to allow a purchasing partner P effectively set off his share in the partnership against the price which he has to pay for a particular asset. P would agree to pay the purchase price and this would be included in the accounts as the value of the asset concerned. P’s capital account would be adjusted accordingly and would be set off against the purchase price. P would normally be expected to pay a deposit pending the calculation of the set-off.
31. The majority of partners (either in number or by partnership share) may apply to the Court for an Order that they be entitled to buy out the minority usually at the date of dissolution at a price to be determined by the Court. As remarked by Hoffmann LJ in Hammond v Brearley Syers v Syers is more often cited than applied. It is an unusual order because it deprives the minority of the ability to test the market so as to ensure that the assets of the partnership are sold at the best price obtainable.
32. The Court is reluctant to order a sale of the assets of a NHS funded medical practice because this may involve indirectly the sale of goodwill which is made illegal by statute. The Court ordered physical partition instead in Rodway v Landy [2001] Ch 703.
33. If a partnership business has a goodwill, then the same ought to be sold as part of its winding-up. The difficulty is that the goodwill is only likely to have substantial value if the business can be continued until the sale takes place. Under section 38 of the Act each partner is required to complete any unfinished business, but is generally not entitled to take on any new business involving long term contracts because this would necessarily involve the continuation of the business of the partnership after dissolution. Such businesses as shops pose no real difficulty because there are no long term contracts which need to be entered into. The problem arises mainly in relation to professional partnerships. In Browell v Goodyear, 14th March 2000 (unreported) the Court rejected the submission that a dissolved firm of solicitors could be required to take on new business. If such a business is to be continued so that the goodwill can be maintained, the new business has to be taken on by one or other of the partners in their own right on the basis that if and insofar as they acquire some or all of the goodwill through their taking on of new business they will need to account for the same.
34. In Boghani v Nathoo [2011] 2 BCLC 704, the partnership business involved property development on a prodigious scale. The partnership was dissolved mid way through the development and the applicant sought orders requiring the respondent to assist in completing the contracts required for such development. The Chancellor held that it was not necessary to complete the contacts as the development could be sold at the stage which had been reached and the application was refused. The case provides little guidance as to when partners can be obliged to complete partnership contacts in order to facilitate the most profitable winding-up possible as most of the considerations raised were practical ones.
4) MANAGEMENT OF THE PARTNERSHIP BUSINESS UNTIL SALE
35. The general rule remains that the Court will not interfere in the management of a partnership save where dissolution is sought. It will then only do so for the purposes of assisting in the orderly winding-up of the affairs of the partnership.
36 Following dissolution, each partner is under a duty to assist in the conduct of the business of the partnership until winding-up. No partner has any better right to do so than another. If the former partners cannot co-operate in this regard, in most cases it will be obvious which partners should manage the business pending winding-up. If necessary, application can be made to the Court for the following
1) An Order precluding other partners from interfering with the management of the business
2) The appointment of a receiver
3) The appointment of a receiver and manager.
In practice, the number of such applications has decreased markedly in recent years.
5) SECTION 42 ACCOUNTS
37. Where a partnership is dissolved and the continuing partner or partners conduct the business pending winding-up, the outgoing partner is entitled to seek an account under section 42 of the Act in respect of the period between dissolution and winding-up. He can elect to claim a account of such share of the trading profits made since the dissolution as the court may find to be attributable to the use of “his share of the partnership assets” or interest at a rate of five per cent per annum on “the amount of his share of the partnership assets”. As stated above, the section 42 account needs to be taken after the assets of the partnership have been sold because there is no cut off point until such time.
38. Capital profits (such as the profits generated upon the sale of partnership land on winding-up) are not covered by section 42. Unless otherwise agreed, the partners will share capital profits as they share trading profits. The draft accounts prepared on dissolution will be adjusted to take into account subsequent sales and the partners credited with the capital profit produced.
39. In practice, the outgoing partner will often opt for interest under section 42 because of the costs involved in calculating the trading profit generated after dissolution and the difficulty in establishing the proportion of such trading profit which was generated from the use of partnership assets as opposed to the efforts of the continuing partner or partners.
6) LITIGATION ISSUES
40. Specific dispute resolution issues will involve the following:
1) County Court Jurisdiction
2) Protocol compliance
3) Initial disclosure
4) Limitation
5) Statements of case
6) Costs
1) County Court Jurisdiction
41. The winding-up jurisdiction of the Court is determined by the net assets of the partnership. When the equity jurisdiction limit was £30,000 this meant that nearly any partnership dispute worth litigating had to be brought in the High Court. As the equity jurisdiction is now £350,000 many partnership claims can be brought in the County Court albeit as Business and Property Work. Given the need for accounts at some stage, this would need to be in a County Court which has BPC District Judges available.
2) Protocol compliance
42. No specific Pre-Action Protocol applies to partnership claims. However, the parties are expected to comply with the Protocol Practice Direction. The most important part if the exercise which is required is in determining what is actually in issue between the parties. Before a claim is commenced, the Court would expect draft accounts to dissolution to be prepared from which the value of the issues between the parties can be assessed.
3) Initial disclosure
43. The better view is that initial disclosure in the BPC is limited to what are likely to be the main issues to be tried by the Judge and not issues relating to the taking of accounts. This makes initial disclosure quite limited.
4) Limitation
44. Section 43 of the Act provides that the amount due to from surviving or continuing partners to an outgoing partner in respect of the share of the latter is a debt accruing at the date of dissolution. Accordingly, the claim by the outgoing partner for an account can only be commenced on dissolution and will become statute barred when the debt relied upon becomes extinguished. This will be 6 years after dissolution unless the partnership was by deed in which case the limitation period will be 12 years from dissolution. The date when the debts of the partnership are actually paid by one partner is not relevant (see Marshall v Bullock, 27th March 1998, CA).
45. However, limitation will only be relevant where all that is being considered is the payment of partnership debts by some but not all of the partners. If the partnership owns property, then the issue between the parties will be the extent to which each is entitled to share in the proceeds of sale of the property taking into account the respective capital accounts of the partners. This is a claim to recover from a trustee trust property or the proceeds of trust property in the possession of the trustee or previously received by the trustee and converted to his use to which section 21(1)(b) of the Act applies. There is no limitation period.
4) Statements of case
46. Before the CPR it was common to see statements of case in a partnership claim which did nothing more than recite the terms of the partnership and the fact of its dissolution and ask the Court to wind-up the partnership and ask for “all appropriate accounts, inquiries and directions”. What would often happen was that the issues of the case would only be revealed at a late stage of the claim after considerable legal costs had been incurred. Statements of case ought to identify partnership property.
47. A partnership claim is unusual in that there is no natural claimant. The claimant is the partner who issues first. Leaving this point aside, it is really incumbent upon the claimant to identify the issues of the claim and (if possible) to put forward a set of accounts to dissolution which he contends for.
5) Costs
48. Before the CPR, it was the long established practice that all the costs of proceedings consequent on a dissolution (as opposed to costs relating to issues as to the existence of the partnership or as to the existence of a binding dissolution agreement) should be paid out of the partnership assets unless there was some good reason for making another order (see Hamer v Giles (1879) 11 Ch D 942, CA). One exception to the practice was where one partner assumed an obligation to prepare accounts and costs were incurred because of his failure to do so. Of necessity, the practice of awarding costs out of the partnership assets involves two sets of assessment of costs because one partner can apply for the assessment of the costs incurred by his other partner or partners. A simple way of achieving the same result is for there to be no order as to costs.
49. Over time, the general practice of the Court has been eroded by the (otherwise helpful) practice of isolating particular issues with regard to the taking of an account and trying them separately. If the issue between the parties is as to the value of goodwill (on the assumption that one has agreed to purchase the same at a value to be determined by the Court) the Court will usually award costs in relation to that issue in isolation at least where the production of accounts following the finding is merely a matter of arithmetic.
50. It is clear that a Calderbank offer can be made in an action for an account. A more difficult issue is whether a Part 36 offer can be made. Lindley suggests that it can albeit that it would have to be formulated by reference to individual issues on the taking of the account (paragraph 23-120 of the current edition). However, the problem with a Part 36 offer is that the same carries with it the offer of costs if and insofar as the other party accepts it. This is not helpful in a partnership claim. Also, it achieves little in a partnership claim if some but not all of the issues between the partners are resolved. As stated above, all issues have to be resolved so that dissolution accounts can be produced. It is submitted that the Calderbank route is the preferable one to take.
51. A partnership claim normally involves the determination of fundamental property or other issues between the partners and thereafter the taking of accounts. In dealing with the fundamental issues the Court will usually make a contentious costs order dealing with all costs to that point. It is always good practice to ensure that the assessment of costs will be immediate because CPR Part 47.1 provides that the assessment of costs is usually to be undertaken at the end of the whole claim. Even without such a direction, the better view is that costs can be assessed immediately because of a partnership claim is a classic two stage claim. In Molnlycke AB v Proctor & Gamble [1993] FSR 154 Morrit J held that there would normally be such an immediate assessment of costs in a patent interference claim because that was a classic two stage action.
52. As regards cost budgeting, the Court will normally order this up to the trial. Thereafter, it will usually be dispensed with not least because there is no provision for post trial costs.
