Legal entities, such as partnerships, are formed every day by people who embark on new ventures. Many do not take the time to draft a written contract, but rather choose to operate under an oral or implied agreement. However, a written agreement is preferred, as it clearly defines all respective rights and responsibilities of the parties. The signed agreement becomes a legally enforceable contract; and because it is in writing, it has more weight in court, should the parties find themselves in litigation.
According to the Uniform Partnership Act, which was created in 1914 and adopted by most states in the US, a partnership is an association of two or more persons to carry on, as co-owners, a business for profit. There are two types of partnerships, both of which are based on the amount of liability the partners have. General partners are responsible for and manage all aspects of the business, but they have unlimited liability which means they are personally responsible for the debts of the partnership. Limited partners, on the other hand, contribute capital only and are not personally responsible for any partnership debts. As the name implies, their liability is limited to the amount contributed.
The purpose of having a Partnership Agreement is to balance the rights (benefits) and responsibilities (obligations) of the general partners; and the same is true for all written contracts, as a general rule. The agreement should stipulate how much money partners may withdraw and under what circumstances money should not be withdrawn. This is important because if one partner depletes partnership funds, the remaining general partner will be put in the position of having to pay debts out of his/her personal funds. Aside from this being grossly unfair, it is damaging to the partnership. Therefore it is important to discourage this behavior and to afford the affected partner with a legal means of enforcement.
Additionally, the agreement should also discuss what happens when events that trigger legal dissolution take place. For example, if one partner should pass away, file bankruptcy or resign, the partnership, in general, is automatically dissolved. Therefore it is important to agree in advance as to whether partners may pass partnership interests to an heir or whether their interest should go to the remaining partner to carry on the day-to-day aspects of the business. Without a written agreement, a partnership interest may pass to an heir leaving the remaining partner with the unforeseen burden of having to pay all of the partnership debts from personal assets.
It is important to know that the Partnership Agreement is a legally binding contract, despite the fact that it is voluntarily entered into by the co-owners of a business. Once signed, it becomes enforceable by law. The Partnership Agreement may be amended from time to time and should be reviewed at least once a year to amend, in writing, any major changes that have taken place. Also, the agreement remains in effect until the partnership is dissolved, which can happen by death, bankruptcy, resignation of one party, or by agreement of both parties.
Keith Ng does online legal services and consulting, particularly with legal writing and documents relating to business. He also offers advice on customizing your agreements and recommends referring to these online Partnership Agreement templates should you prefer to draft one yourself.