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Part 1: Partnerships – Am I in One and Why Does it Matter?

Posted on 6th March 2012

Looking back over the past century, some of the greatest contributions to our society have come from the collaboration between entrepreneurs. Business icons such as the Wright Brothers, the Warner Brothers, Bill Gates and Paul Allen, Steve Jobs and Steve Wozniak and more recently the likes of Sergey Brin and Larry Page have shaped the way we live, laugh, travel and communicate. There’s no denying that in each of these business relationships, the dynamic tension between the two thought leaders helped them drive innovation, turn conventional thinking on its head, and achieve a level of success they likely would not have reached on their own.

In a legal sense, collaboration between two or more entrepreneurs can take various forms. One legal vehicle that is often utilized in the small business context is that of a partnership. In this post we will discuss what a partnership is under British-Columbia (BC) law and why it’s important to know if you are in one.

What is a Partnership?

Under the BC Partnership Act, a partnership automatically exists where there are two or more persons carrying on a business in common with a view to profit. In understanding partnership law, it is fundamental to note that a partnership is not a legal entity separate from the partners. This is different than a corporation or trust, which is treated legally as an entirely separate person. One consequence of the fact that partnerships are not separate entities is that a partner cannot become an employee of the partnership. This is because doing so would require him to contract with himself, which is not permissible under the law. A second consequence of even greater importance is the fact that all the profits of the partnership accrue directly to the partners, and all partners are personally liable for the debts and obligations of the business. This is a distinction many businesspeople don’t properly understand, often thinking that the assets and liabilities of the business are separate from their own. A final point worth noting is the fact that each partner is liable to perform the contractual obligations contracted by other partners within the scope of the business, even where the other partner did not consent to the particular obligation. This would be the case where one partner in a two-man painting operation agrees in the name of the partnership to paint the house of a good friend at a very low price. Even though, the other partner might not agree, both partners are liable to perform under this contract.

Are You In a Partnership?

Going back to our definition of a partnership, we can see that there are three key elements: “carrying on a business”, “in common”, and a “view to profit”. “Carrying on a business” has been very broadly defined to include “every trade, occupation and profession”. It’s also important to note that these words have been held by courts to cover both ongoing activity as well as a single transaction. The words “in common” signify that the partners are acting together based on some kind of agreement be it written, oral or implied. The “view to profits” means that the businesses operations are not for charitable, social or cultural purposes. Finally, Canadian courts have ruled that for a partnership to exist there need not necessarily be any profits, the partners only have to aim to make profits.

In some cases, the existence of a partnership will be quite evident. For example, you could run a catering business with your brother-in-law – he shops for the groceries, delivers the meals, takes orders and does all the bookkeeping. You are responsible for creating a weekly menu for clients as well as preparing and packaging the food. You’ve both agreed to this division of labour and to a 50/50 split of all profits. Although, you haven’t signed anything you’ve entered into a legal relationship!

However, in other cases the existences of a partnership will be less clear. If a business owner is unsure of whether they are in fact in a partnership situation, it’s worthwhile to take a moment to reflect on these general guidelines and consult a lawyer.

Why Does It Matter?

You might be asking yourself: so what if I’m in a partnership? What’s the big deal? The big deal is that you might have legal obligations towards your partner and the business that you didn’t even know you had.

Of course, the most important obligation would be that of liability, a fancy legalese term meaning to be legally bound to the payment of a certain debt. As we saw earlier, a partner is bound to perform the contracts entered into by any of the other partners (e.g. painting the friend’s house!). A partner can also be held liable for any torts committed by his partners made in connection with the business. A tort is an act, thought not necessarily illegal, which causes harm to another person. Returning to our catering example, you could be liable in tort if your brother-in-law, driving your business’s truck, ran a red light and struck a pedestrian. Finally, a partner is also liable for omissions or negligence acts by employees of the partnership committed in the scope of their employment under a legal theory known as vicarious liability.

Conclusion

It’s in every small business owner’s interest to periodically review the relationships they have with all the stakeholders in their business. If you have an undefined relationship with another party, there are legal steps that can be taken to clarify these relationships.  Firstly, you could structurally change any relationships you are in following the general guidelines courts have used to determine whether a partnership exists. Secondly, a clause could be inserted in all future contracts clearly defining the nature of the relationship. Finally, the most elaborate solution is that of a partnership agreement. This is a signed legal document outlining the regulation of the relationship amongst the partners, as well as how the partnership will conduct business. Most importantly, partnership agreements allow the partners to modify the default provisions that would otherwise apply of the Partnerships Act, and to structure the partnerships’ affairs to allocate liability between the partners.

Now that we’ve given you some food for thought, in the next post we’ll do a more in-depth examination on partnership agreements, and how they can be a useful tool for small business owners.