The biggest mistake made by partnerships is not having a well drafted partnership agreement. Although California law does not require a partnership to have a written agreement, a well written partnership agreement is strongly recommended because: (1) the default partnership rules typically do not mirror the partners’ intent; (2) a clearly written partnership agreement will set forth the essential terms and outline each partners rights and responsibilities, and (3) should a dispute arise between the partners, the partnership agreement will help to resolve a dispute that otherwise might cost tens of thousands of dollars to litigate.
Issues That Should Be Addressed In Every General Partnership Agreement.
At a very minimum, a written partnership agreement should set forth the purpose of the partnership business and exactly what is expected of each partner in terms of time, duties, and financial contributions. For example, will one partner be putting up the financial capital while the other partner puts in the work? If so, I guarantee there will be times when the person doing all of the work feels they are entitled to a bigger piece of the pie and times when the financial partner feels the other partner isn’t working hard enough. For this reason, it is extremely important that the partners have an understanding from the beginning as to what is expected from each partner. A written partnership agreement should also specify whether additional compensation will be paid to a partner who performs work at some particular time (e.g. after so many years, after the financial partner has recouped his or her investment, if additional work is performed, etc..) A written partnership agreement should also specify with great detail when and how the profits of the partnership will be split, and how losses will be divided and paid. Other terms that should be included in any written partnership agreement include:
- Term of the partnership.
- Purpose of the partnership and what outside competitive activities the partners may engage in.
- Initial capital contributions of the partners (including money, services, and property).
- Subsequent capital contributions. If the partnership needs additional capital, will the partners be obligated to make additional capital contributions?
- How the partnership profits and losses will be allocated among the partners, and when.
- How the partnership will be managed, including who will make the day-to-day decisions, who will be responsible for what duties, and what acts will require majority approval or unanimous consent.
- How much time each partner is expected to devote to the partnership business.
- Whether new partners can be added, and if so how.
- Under what circumstances a +partner can be expelled.
- How a partner can withdraw.
- Which partner(s) will have signature authority on the bank accounts.
- A means to resolve a deadlock or conflict.
- A provision providing for the dissolution of the partnership and formation of a California corporation or LLC if the partnership business reaches some milestone.
In addition to, or as part of, a written partnership agreement, the partners should also execute a buy-sell agreement to address the issue of the transferability of their partnership interest. Absent an agreement to the contrary, a partner may freely transfer his or her partnership interest to another person. In addition, absent an agreement to the contrary, the death, incapacity, bankruptcy, resignation or expulsion of any partner may automatically dissolve the partnership. To provide continuity, a buy-sell agreement can provide effective buy out provisions to address various situations.