Partnership Law [2003] SLC 192(4) (Report) (November 2003)

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URL: http://www.bailii.org/scot/other/SLC/Report/2003/192(4).html
Cite as: [2003] SLC 192(4) (Report)

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PART IV

THE DEFINITION OF PARTNERSHIP

Introduction

In section 1 of the 1890 Act the existing definition of partnership is as follows:

Partnership is the relation which subsists between persons carrying on a business in common with a view of profit.

4.2

The definition raises a number of issues which we discussed in the Joint Consultation Paper.

^[1]

Issues arising out of the existing definition

The use of the expression "relation"

In the Joint Consultation Paper we suggested that the use of the expression "relation" was out of touch with ordinary usage. This is so particularly among people who are not lawyers. A lawyer may think that "relation" is a suitable expression to describe the connection between a particular group of partners but it is not appropriate for a continuing partnership which survives changes in membership. Just as an agreement between A, B and C is seen as different from an agreement in identical terms between B, C and D, so also a relationship between the former persons is seen as different from a relationship between the latter.

The need for agreement

4.4

Partnership arises out of an agreement between the partners.

^[2]

Carrying on business with a view of profit

A partnership is a vehicle by which persons carry on business. This distinguishes it from non-business associations. "Business" is widely defined as including "every trade, occupation, or profession".

^[3]

The definition requires the partners to carry on the business before there can be a partnership. Lord Lindley in his Supplement on the 1890 Act

^[4]

Khan v Miah

^[5]

^[6]

Who carries on the business?

The existing definition envisages that it is the partners who carry on the business of the partnership. This is consistent with the aggregate approach to partnership which English law adopts,

^[7]

^[8]

^[9]

^[10]

^[11]

Our provisional proposals and consultation

^[12]

Partnership as an "association"

A majority of consultees supported the proposal to replace the expression "relation" with "association". The APP suggested that the definition should be consistent with the statutory definition of a limited liability partnership in order to facilitate the conversion of an ordinary partnership into an LLP.

^[13]

The need for agreement

There was support for our proposal that the definition should make clear that the association must be constituted by agreement, although several consultees argued cogently that it was not necessary as the existence of an agreement is implied, and such a definition might be harmful if it gave the impression that express agreement was required.

When a partnership is formed

4.11

There was support for our proposals in relation to the commencement of a partnership but several consultees expressed the view that the House of Lords had resolved the matter in Khan v Miah.

^[14]

Who carries on the business?

The majority of the English and all of the Scottish consultees agreed with the proposal that, if partnerships have separate legal personality, the definition should state that the partnership carries on the business rather than the partners. One consultee, however, expressed concern over the foreign tax consequences of separate personality and of such a definition. Others were concerned that such a definition would change the perception of partnership. One consultee argued that the legal personality of a partnership was simply a legal device which treated the body of partners as a person and was different from the corporate nature of a registered company. Our consultant, Roderick Banks, disagreed with the proposal, arguing strongly that the involvement of the partners in carrying on the business was at the heart of partnership.

The division of profits

4.13

Consultees generally supported the proposal that the division of profits was not an essential feature of partnership.

The rationale for reform

4.14

It seems to us that the existing definition of partnership is inappropriate for four reasons. First, the expression "relation" is opaque and is confusing to people without expertise in partnership law. It describes an underlying relationship between the partners and not the business vehicle. Secondly, "relation" is not suited to a default rule of continuity of partnership and to the existence of separate legal personality. Thirdly, it is necessary to distinguish between the partnership itself and the underlying partnership contract: the terms of a partnership's contractual constitution may change over time without creating a new partnership on each change. Fourthly, the language of the whole of section 1 of the 1890 Act requires updating.

The reform proposals

Who may be partners?

4.15

As we recommend below, in order to constitute a partnership, there must be an agreement between persons to carry on business together with the object of making a profit and those persons must have started to carry on the business together.

^[15]

^[16]

Definition of partnership

We have considered whether to include a definition of "partnership" in the draft Bill and how best to define it in the context of a default rule of continuity of partnership on a change of membership. We think that a partnership is best described as an association of persons. This description is consistent with a partnership which continues in existence on changes of its membership. There are precedents for so describing a partnership in the Revised Uniform Partnership Act (RUPA)

^[17]

^[18]

We therefore recommend that a partnership should be defined for the purposes of the draft Bill as "an association formed when two or more persons start to carry on a business together under a partnership agreement".

^[19]

The need for agreement to constitute a partnership

We think that the draft Bill should make it clear that a partnership must be constituted by agreement.

4.19

We are aware of an argument that such a definition may mislead because it may give the impression that express agreement is required. It may also mislead by seeming to support those who enter into agreements which state that they are not partners when it is clear from their conduct that they are. To avoid the first risk and to reduce the second, we recommend that the definition should make it clear that the necessary agreement may be constituted expressly or inferred from conduct, or may be partly express and partly inferred from conduct. This would be consistent with existing partnership law: where persons agree to carry on business together with the object of making a profit and do so carry on business, they are a partnership. The law looks to the substance and reality of the agreement and "no 'phrasing of it' by dextrous draftsmen … will avail to avert the legal consequences of the contract".

^[20]

We recommend that the definition of partnership should make it clear that a partnership must be constituted by agreement. That agreement may be express, inferred from conduct or may be partly express and partly inferred from conduct. (Draft Bill, cls 1(1) and (2) and 76(2))

The commencement of the partnership

4.21

In Khan v Miah

^[21]

We see no need to be more specific. In particular we are not persuaded that there is benefit in the formula that the commencement date is either (a) the date of the agreement to enter into business or (b) if no such agreement was made, the date when the business itself commences. The first leg of the formulation is flawed, as an agreement to enter into business may specify that the business will commence at a future date.

^[22]

We favour an approach which allows the decision of the House of Lords in Khan v Miah

^[23]

We therefore recommend that a partnership should commence when two or more persons start to carry on a business together with the object of making a profit. (Draft Bill, cl 1(1) and (2))

Partners carrying on the business of the partnership

4.25

Since receiving the responses to the Joint Consultation Paper, we have reconsidered our provisional proposal that if a partnership were to have legal personality the definition should refer to the business being carried on by the partnership rather than by the partners.

^[24]

^[25]

However, if we were so to provide, there would be a striking difference in this context between legal form and economic reality. It is the partners who undertake the practical tasks of carrying on the business. They enter into contracts on behalf of the partnership and bind it. It is the partners who ultimately benefit from the success of the partnership business and who are liable, without limit, for its obligations. The division between management and ownership, which is a paradigm of company law, does not apply in partnership law. The involvement of the partners in carrying on the business is at the heart of partnership. The economic and practical reality of partnership (whether or not the partnership has separate legal personality) is that it depends for its existence on the involvement of the partners in the business.

4.27

In Part V we recommend that all general partnerships should have separate legal personality.

^[26]

There is also another practical reason for providing that it is the partners who carry on the business. It is important to most partnerships in the United Kingdom that they are treated by the Inland Revenue as tax transparent, so that income and gains of the partnership are taxed as the income and gains of the individual partners. The Inland Revenue justify their approach to UK partnerships

^[27]

(1) the partners carry on the business of the partnership with a view to profit;

(2) every partner is liable jointly or jointly and severally with the other partners for all the debts and obligations of the partnership; and

(3) the partners own the business, each having at least an indirect share in the net assets of the partnership.^[28]

It is clearly in the commercial interests of UK partnerships to preserve the existing tax treatment.

At the same time we recognise the importance of clarity in legal analysis, particularly when the introduction of separate legal personality will be a novelty in English law.

^[29]

^[30]

We therefore recommend that it should be provided that it is the partners who carry on the business of the partnership. (Draft Bill, cl 6(1))

4.31

We discuss in Part V below the reasons why we recommend the introduction of legal personality into the English law of partnership. In addition to conceptual clarity and the resolution of practical problems, we see separate personality as an important component of continuity of partnership, which we recommend as a default rule. As a new entity is to be created we think it appropriate to state its main functions in the draft Bill. While the partners carry on the business, it is the partnership which enters into contracts. The partnership can hold property. Separate legal personality also facilitates continuity of partnership for those firms which adopt the default code or where the partnership agreement provides alternative rules for continuity of partnership.

4.32

We therefore recommend that it should be provided that the main functions of the partnership are to enter into contracts and own or hold property for the purposes of the partnership business, and (subject to the partnership agreement) to provide continuity for the partnership business despite a change in the partners. (Draft Bill, cl 6(2))

Partnership as a business vehicle

4.33

We do not favour extending the definition of partnership to include ventures other than business ventures. One consultee suggested that the definition should be expanded so that a partnership could include trustees who conduct business for the benefit of the trust estate and not for personal profit. In our view the definition in the draft Bill is wide enough to encompass a partnership which included partners who were trustees.

4.34

Another consultee suggested that the definition of business in section 45 of the 1890 Act should be extended to include investment activities. Consultees who responded to the Joint Consultation Paper on limited partnerships were divided in their response to a question asking them whether the 1890 Act was adequate for the purpose of limited partnerships. Several argued that there was sufficient doubt about the definition to justify express reference to investment activity. Others, including the Inland Revenue and KPMG suggested that the existing definition included investment carried on as a commercial venture. We agree. We think that the existing definition is sufficiently broad to cover investment carried on as a commercial venture. One consultee suggested that there is no disadvantage in including investment in the definition. But any extension of the definition might create its own problems of interpretation. There is no consensus for change. The Inland Revenue have taken a position on the issue with which we agree. We therefore do not recommend any change to the definition of "business" in the 1890 Act for partnerships generally or for limited partnerships.

^[31]

We therefore recommend that in the draft Bill "business" should include every trade, profession and occupation. (Draft Bill, cl 1(6))

Division of profits

4.36

In the draft Bill a partnership agreement is defined as "an agreement between two or more persons for carrying on a business together with the object of making a profit".

^[32]

^[33]

^[34]

Who is a partner?

We have considered whether it is possible to provide some statutory guidance on the criteria which determine whether a person is a partner.

^[35]

A person can be a partner although he does not, and is not allowed to, take part in management.

We do not think that it would be helpful to have a statutory formulation of a test which is wide enough to encompass the circumstances which may arise in particular partnerships. Nor do we see advantage in altering the test to restrict the circumstances in which a partnership comes into existence. As a dormant partner is still a partner, we cannot use the test of involvement in management.

^[43]

What are not partnerships?

The draft Bill contains a provision

^[44]

^[45]

^[46]

A statement of a partnership's capacity

We think that there should be a statement that a partnership has unlimited capacity to act. Consultees generally supported the proposal. It avoids the application of the rules of ultra vires to partnerships which (if our recommendations are implemented) will have separate legal personality.

^[47]

^[48]

We therefore recommend that there should be a statement that the partnership's capacity as a legal person is unlimited. (Draft Bill, cl 7(1))

Criminal capacity (England and Wales)

4.43

Whether a partnership governed by English law can commit a criminal offence is rather obscure. There are some judicial dicta which indicate that it cannot.

^[49]

Our policy is that a partnership should not be capable of committing an offence unless an Act expressly or by necessary implication provides that it can. Examples of where a statute may show an intention, by necessary implication, that a partnership can commit an offence include certain obligations backed by criminal sanctions which are imposed on an employer or on the registered owner of property. If an employer or owner of a vehicle commits an offence by failure to perform the statutory obligation, the statute would have to apply to a partnership if the partnership were the employer or owner as the case may be. Otherwise the criminal sanction would be ineffective.

4.45

At the same time, we do not intend that a partner, who is otherwise within the scope of the criminal law, should be able to avoid criminal liability by asserting that he was acting on behalf of the partnership. We consider that no such implication arises through the introduction of separate legal personality.

4.46

The question whether the criminal law should apply more generally to partnerships raises issues of criminal law policy on which we have not consulted. It is something which ought to be considered on a wider basis as it raises, among others, the issue of what principles should apply to make a partnership guilty of offences which involve mens rea. This is beyond the scope of this project. What we propose is a workable holding position pending a more thorough consideration of the criminal law in relation to partnerships.

^[50]

We therefore recommend that except so far as is provided by or under any enactment, whether expressly or by necessary implication, a partnership should not be capable of committing an offence. (Draft Bill, cl 8)

Rules for determining the existence of a partnership

4.48

In the Joint Consultation Paper,

^[51]

^[52]

Consultees were divided on the proposal to repeal section 2. While a small majority of consultees agreed with the proposal, a significant number of consultees stated that they found the guidance useful or otherwise argued for its retention.

4.50

On further consideration, we have departed from our provisional proposal. We recognise that many practitioners continue to find the guidance useful. We note that RUPA has preserved similar rules.

^[53]

In so doing, we aim to retain the substance of section 2 of the 1890 Act.

^[54]

^[55]

^[56]

Consultees supported the repeal of the requirement, in section 2(3)(d),

^[57]

We therefore recommend that the guidance in section 2 of the 1890 Act for determining the existence of a partnership should be re-enacted in modern language subject to the repeal of the proviso to section 2(3)(d). (Draft Bill, cl 1(7) and Schedule 1)

Concepts in the draft Bill

Partnership agreements

4.54

We discussed above the need for an agreement to constitute a partnership and we emphasised that the agreement or any of its terms may be express or inferred from conduct.

^[58]

We therefore recommend that a partnership agreement may be varied in accordance with its terms or with the agreement of all existing partners (or before the formation of the partnership with the agreement of all proposed partners). (Draft Bill, cl 4)

Default partnership rules

4.56

The flexibility of partnership law depends on allowing partners to determine the terms of their agreement. The 1890 Act, by creating default rules which govern the relationship between the partners subject to any contrary agreement, preserves this flexibility. Section 19 of the 1890 Act provides:

The mutual rights and duties of partners, whether ascertained by agreement or defined in this Act, may be varied by the consent of all the partners, and such consent may be either express or inferred from a course of dealing.

4.57

We aim to preserve this flexibility and also to make clear which of the rules in the draft Bill are default rules and which are not. This we do by stating in each clause whether or not it is a default rule. We consider that it would be useful also to define a default rule as a rule which applies in relation to a partnership if the point dealt with in the rule is not dealt with in the partnership agreement. As default rules confer rights and duties on partners which the partners may wish to enforce against each other, we think that there should be a statement of the status of the default rules as terms of the partnership agreement. They perform the function of statutorily implied terms and we propose that a default rule should be treated as if it were a term of the partnership agreement so that partners may enforce their rights against each other in contract.

^[59]

^[60]

We therefore recommend that:

(1) A default rule should be defined as a rule which applies in relation to a partnership if the point dealt with in the rule is not dealt with in the partnership agreement;

(2) If a default rule applies in relation to a partnership it should be treated as if it were a term of the partnership agreement; and

(3) The partners may modify or exclude the application of a default rule in relation to a partnership in accordance with the partnership agreement or if all the partners agree. (Draft Bill, cl 5)

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Note 1    Joint Consultation Paper, paras 5.1 – 5.26.    [Back]

Note 2    Lindley & Banks, para 2-13. Roman law treated partnership as a consensual contract and the Scottish Institutional writers referred to it as a contract or association: Erskine Institutes III.3, 18, Bell Principles, s 351.    [Back]

Note 3    1890 Act, s 45.    [Back]

Note 4    The Supplement was to the 5th edition of Lindley on Partnership (1888) and was published in 1891 (hereinafter “the Supplement”). See the Supplement p14.    [Back]

Note 5    [2000] 1 WLR 2123.    [Back]

Note 6    Ibid, Lord Millett at p 2128.    [Back]

Note 7    See para 2.5 above.    [Back]

Note 8    1890 Act, s 4(2). See also Major v Brodie [1998] STC (Ch D) 491.    [Back]

Note 9    1890 Act, s 5.    [Back]

Note 10    1890 Act, ss 9 and 12.    [Back]

Note 11    The entity approach treats the partnership as a legal person distinct from the partners who compose it. This, asLindley & Banks, paras 3-01 – 3-03 record, reflects the commercial view of partnerships. The separate legal personality of partnerships which are entities, such as partnerships in Scotland and the United States, does not make them corporations. The legal personality of a partnership is sui generis. See Part V below.    [Back]

Note 12    See the Joint Consultation Paper, para 5.26.    [Back]

Note 13    The Limited Liability Partnerships Act 2000, s 2 provides that for an LLP to be incorporated there must be “two or more persons associated for carrying on a lawful business with a view to profit”. We believe that our definition of partnership (para 4.17 below) is consistent with this definition and will not prevent conversion from a general partnership to an LLP.    [Back]

Note 14    [2000] 1 WLR 2123.    [Back]

Note 15    See para 4.20 below. As we state in para 4.21 below, in this context the partners can begin to carry on business when they fit out their shop; they do not need to be trading for the partnership to come into existence.     [Back]

Note 16    See the draft Bill, cl 1(1), (2) and (7).    [Back]

Note 17    RUPA was finalised by the National Conference of Commissioners on Uniform State Laws in 1994.    [Back]

Note 18    See RUPA, s 101(6), which describes partnership as “an association of two or more persons to carry on as co-owners a business for profit”. See also Bell Principles, s 351.    [Back]

Note 19    We have used the expression “under a partnership agreement” rather than “as a result of “ or “in accordance with” a partnership agreement. It was suggested to us that “as a result of” could be interpreted so that there required to be a pre-existing agreement for a partnership to come into existence and that this would militate against a partnership coming about by actions. The expression “in accordance with” was criticised as carrying the implication that the partners would have to comply with every term of their agreement for a partnership to come into existence. As we wished to avoid any implication of temporal sequence or of mandatory conformity to the agreement we have used the neutral word “under”.     [Back]

Note 20    Adam v Newbigging (1888) 13 App Cas 308, 315 per Lord Halsbury. In Weiner v Harris [1910] 1 KB 285, 290 Cozens-Hardy MR stated: “Two parties enter into a transaction and say “It is hereby declared there is no partnership between us”. The Court pays no regard to that. The Court looks at the transaction and says “Is this, in point of law, really a partnership?” It is not in the least conclusive that the parties have used a term or language intended to indicate that the transaction is not that which in law it is.”     [Back]

Note 21    [2000] 1 WLR 2123.    [Back]

Note 22    See Dickinson v Valpy (1829) 10 B & C 128, Parke J at 141-142.    [Back]

Note 23    [2000] 1 WLR 2123.    [Back]

Note 24    Joint Consultation Paper, para 5.26(4).    [Back]

Note 25    See para 6.22 below.    [Back]

Note 26    We recommend in Part V that the legal personality of a partnership should be sui generis. It would not be a body corporate. So the law of corporations which separates the liability of the corporation and restricts the liability of the members of the corporation will not be relevant.    [Back]

Note 27    This covers both the English law partnership and the Scots law partnership notwithstanding that the former has no separate legal personality and the latter has separate legal personality.    [Back]

Note 28    See Memec plc v Commissioners of Inland Revenue (1998) 71 TC 77 and in particular Peter Gibson LJ at pp 111-113. Neither the separate personality of the Scottish partnership nor the absence of mutual agency in Scots law prevented the conclusion that in substance the position of the partners in a Scottish partnership in relation to the profits was the same as in an English partnership (p 113B-C).    [Back]

Note 29    In making the recommendation in paragraph 4.30 below we recognise that we are departing from the views of the majority of consultees (see para 4.12 above).    [Back]

Note 30    See paras 6.59 and 6.62 below.    [Back]

Note 31    See paras 16.24 – 16.26 below.    [Back]

Note 32    Draft Bill, cl 1(1).    [Back]

Note 33    Draft Bill, cl 1(2).    [Back]

Note 34    In this example, the partners would have contracted out of the default code to provide that D, although a partner, would receive a fixed sum rather than a proportional share of the profits. See paras 4.37 – 4.39 below.    [Back]

Note 35    The difficulty to which the informality of partnership gives rise has long been recognised. In a parliamentary debate in 1828 Henry Brougham stated: “It would be difficult to point out greater uncertainty or more caprice in any branch of the system than are to be found in the law of Partnership. A man can hardly tell whether he is a partner or not; being a partner, the extent of his liability is scarcely less difficult to ascertain; and he will often find it in vain to consult his lawyer on these important matters” (Parliamentary Debates, 2nd Series, Vol 18, 1828, column 241). While case law since 1828 may have reduced the caprice, the uncertainty arising from informality may remain.    [Back]

Note 36    Pooley v Driver (1877) 5 Ch D, 458, 477.    [Back]

Note 37    Ibid, at p 473.    [Back]

Note 38    Cox v Hickman [1860] 8 HL Cas 268; Mollwo, March & Co v Court of Wards (1872) LR 4 PC 419.    [Back]

Note 39    See Stekel v Ellice [1973] 1 WLR 191, 198 - 199.    [Back]

Note 40    As in Pooley v Driver (1877) 5 Ch D 458 and Stekel v Ellice [1973] 1 WLR 191.    [Back]

Note 41    As in Mollwo, March & Co v Court of Wards (1872) LR 4 PC 419.    [Back]

Note 42    As in Walker v Hirsch (1884) 27 Ch D 460.    [Back]

Note 43    Such a test would also be unsuitable in a limited partnership.    [Back]

Note 44    Draft Bill, cl 2.    [Back]

Note 45    Although a company cannot be a partnership it can be a partner.    [Back]

Note 46    Draft Bill, cl 2.    [Back]

Note 47    There is also a precedent in relation to limited liability partnerships in the Limited Liability Partnerships Act 2000, s 1(3): “A limited liability partnership has unlimited capacity”.    [Back]

Note 48    It is not simply a question of vires; it is also a question of legal capacity: for example cl 7(2) which allows a partnership to sue and be sued in the partnership name falls into the latter category.     [Back]

Note 49    See, for example, Davey v Shawcroft [1948] 1 All ER 827, 828 d-h, per Lord Goddard CJ.    [Back]

Note 50    We do not propose to make provision for Scotland where the partnership already has a form of separate personality and is capable of committing certain criminal offences.    [Back]

Note 51    Joint Consultation Paper, para 5.43(1).    [Back]

Note 52    See para 4.19 above.    [Back]

Note 53    RUPA, s 202.    [Back]

Note 54    The wording of s 2 has been criticised and can be improved. See Lindley on Partnership (5th ed 1888) Supplement pp 18-19 and G. Morse, Partnership Law (5th ed 2001) pp 49-57.    [Back]

Note 55    1890 Act, s 2(3); Badeley v Consolidated Bank (1888) 38 Ch D 238, 258 per Lord Lindley.    [Back]

Note 56    1890 Act, s 2(1) and (2).    [Back]

Note 57    “The advance of money by way of loan to a person engaged or about to engage in any business on a contract with that person that the lender shall receive a rate of interest varying with the profits, or shall receive a share of the profits arising from carrying on the business, does not of itself make the lender a partner with the person or persons carrying on the business or liable as such. Provided that the contract is in writing, and signed by or on behalf of all the parties thereto… .” The words in italics are the proviso which we recommend should not be re-enacted.    [Back]

Note 58    Paras 4.18 – 4.20 above.    [Back]

Note 59    This is subject to the exclusion of contract law doctrines as grounds for breaking up a partnership. See para 8.124 below.    [Back]

Note 60    Partners will not be able to modify or exclude default rules which have conferred rights on a former partner without his consent. See para 8.81 below.    [Back]

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You are here: BAILII >> Databases >> Scottish Law Commission >> Scottish Law Commission (Reports) >> Partnership Law [2003] SLC 192(4) (Report) (November 2003) URL: http://www.bailii.org/scot/other/SLC/Report/2003/192(4).html Cite as: [2003] SLC 192(4) (Report)