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Detailed agreement key when creating partnership structure

A partnership can be a flexible and desirable option for many businesses, but its success can be largely dependent on a strong partnership agreement that addresses a number of current and future concerns, Vancouver corporate lawyer Jonathan Reilly tells AdvocateDaily.com.

“The Business Corporations Act has many protections for shareholders built into it. Shareholders have an oppression remedy, they have what’s called a derivative action where the shareholders can apply to have the directors be ordered to do things. There are no such protections for partners in the Partnership Act. You have a lot of freedom to make your partnership agreement unique or reflect your circumstances," explains Reilly, founder of English Bay Law Corporation

In most jurisdictions, there are several types of partnership — and some individuals may be in one without knowing it.

“In B.C., there’s a general partnership which does not require a written agreement in order to exist. In a general partnership, every partner has an unlimited liability for the liabilities of the partnership. One partner goes out and does something and it loses money, every partner is responsible to make good on it.

"You can find yourself in a general partnership unwittingly because the pursuit of an objective for profit with another person is a partnership at law. So, you may not have intended to put yourself in a partnership but you can actually be in one without knowing it, in legal terms.”

In addition, Reilly says partners owe fiduciary duties to one another and cannot deprive the partnership of its rightful revenue. Individual partners are also responsible for not competing with the alliance.

Other types are registered and include limited partnership and limited liability partnership.

“In a limited partnership, you have one partner who has a limited liability to the debts and obligation of the partnership — usually we incorporate a corporation and make that the general partner. The other partners are similar to shareholders. We call them limited partners because their obligation is limited to paying for their partnership unit just like a shareholder’s obligation is limited to paying for their shares.”

However, in a limited partnership, says Reilly, that protection can be broken.

“If a limited partner takes part in the day-to-day operations and decision-making of the limited partnership, they lose that protection. They can inadvertently convert themselves into a general partner.

“So, the idea is, you have a general partner who runs the business and then you have silent partners, the limited partners are financial partners only. They put money up for the business and they don’t take part in making decisions of the business. If you take part in making decisions for the business, you become responsible for the business.”

A limited liability partnership is generally used by professionals who are each responsible for their own errors, says Reilly.

From a tax perspective, Reilly says partnerships are important tools as they are not a recognized legal person under the Income Tax Act.

“The partnership goes out, does its business and pools its expenses and its revenue and at the end of the day, the net income gets distributed among the partners. The partnership doesn’t pay tax, each partner pays tax in their own hands, in their own circumstances,” he says.

However, he cautions, a limited partnership could find itself paying the highest rate of tax if any of its members are found to be non-residents.

“It’s very important, first of all, if you’re a limited partner, that you don’t take part in day-to-day decision-making. That’s the first problem that you really need to be very careful to avoid. And the second thing that’s very important to avoid is that none of the limited partners can be non-resident. If they are, it destroys the tax planning of the limited partnership and it will be assessed the highest rate of tax,” says Reilly.

When determining the right partnership structure for a business, lawyers and accountants will look at the type of business, the positions of the partners and the objectives of their investment.

An important difference between a general partnership and a limited partnership, says Reilly, is that a limited partnership must be registered and have a written agreement.

“Even if you’re in a general partnership that’s working and everybody is happy with it but there’s no written agreement, it’s very important to have a written agreement that acknowledges that the partnership continues even if a partner dies. Without that written agreement among the partners, if one of the partners dies, the entire partnership comes to an end. And that could be a very bad tax circumstance that no one’s prepared to pay for.”

The considerations in a partnership agreement will differ depending on whether it consists of a group of people who intend to work together — for example, lawyers, doctors, developers — or whether the arrangement involves one person looking for investors for their project or business.

“A partnership where there’s someone pursuing a business and they need several silent investors, that’s not as troublesome. But a partnership where there’s a lot of people or even if two or three or four people come together and they all going to work together, there’s many more concerns that will need to be addressed.”

“These agreements are always drafted when everyone is getting along but they deal with the topics of what happens when you stop getting along, so nobody really wants to think about it," he adds.

A good partnership agreement will speak to questions of decision-making, who has the authority to spend money, capital items, divorce, death, bankruptcy, as well as voluntary and involuntary exits from the partnership.

“The partnership agreement will cover things that you hope will never happen. What happens if someone dies, what happens if we start to fight, how do we divide up things or how do we get someone out that everyone else has decided needs to go?”

A good partnership agreement will also address expectations.

“If there’s an expectation that this business is going to work because everyone is putting in sweat equity — what happens if a partner isn’t pulling their weight, how do you determine what their weight is supposed to be and whether or not they’re pulling it? And what happens in a deadlock?”

Ultimately, while there is room and flexibility to be creative within a partnership agreement, this structure is not for everyone.

“It’s not for every business — you have to start by getting advice from your accountants and your lawyers,” says Reilly.

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