This article is written by Gunjeeta Jangra in her first semester at the National Law Institute University, Bhopal.
ABSTRACT
A commercial partnership is a kind of business arrangement in which two or more individuals, according to their capacities and preferences, come together to run and evolve a business idea. There are various kinds of arrangements in commercial partnerships depending upon various factors. These may be general as well as limited liability partnerships. The partners share the resources, liabilities, profits, as well as losses or debts incurred by the business. It is not an uncommon fact that there are many risks involved in business, may it be the legal consequences or the financial risks, which are generally handled by the partners. This research article aims to highlight the risks and their potential results in commercial partnerships which can be mitigated by the partnership agreement to an extent.
Keywords: commercial, partnership, agreement, India, partners, limited liability, business, company, LLP, risks, results, Indian partnership act 1932, limited liability partnership act 2008.
INTRODUCTION
Across the globe, it is a common practice for individuals to get together, run and grow a business and share its profits, losses and resources. Formally, these are called “commercial partnerships” and the individuals are called “partners”. While the term partnership is understandable, there are different aspects and kinds of commercial partnerships. The type of partnership is usually determined based on various factors such as the extent of liability, tenure of the partnership, legal entity or corporate body, etc. Commercial Partnership is not only to run a business and share the profits and losses, but it has its own intricacies too. There are too many risks involved in commercial partnerships, most importantly, the unlimited liability of the partners with their potential results.
In this research article, the author aims to discuss the types of commercial partnerships, highlight the risks and their results, and demonstrate how the partnership agreement with clear and effective provisions can mitigate these risks. Section II of the research article discusses the types of commercial partnerships such as general, limited and fixed-period partnerships, depending on various factors, for instance, the extent of liability or the duration of partnerships. Section III of the article highlights the possible major risks and their potential results arising out of commercial partnerships. Section IV of the article sheds light on the importance of partnership agreements to avoid possible future conflicts and provisions under the Indian Partnership Laws to determine the rights and duties of the partners through contracts.
TYPES OF COMMERCIAL PARTNERSHIP
Section 4 of The Indian Partnership Act, 1932 defines the partnership as “The relation between persons who have agreed to share the profits of a business carried on by all or any of them acting for all.”[1] Before delving into the discussion of potential results, benefits and dangers of commercial partnerships, it is pertinent to give a general overview of the different kinds of commercial partnerships in the businesses.
A partnership is not only coming together, running the business or sharing the profits but can be differentiated on various factors such as the extent of liability of a partner, tenure or duration of the partnership, arising out of contract or not etc. Some of the important types of commercial partnerships such as general partnerships, limited partnerships, limited liability partnerships, partnerships at will, particular partnerships, and partnerships for fixed periods, are mentioned below:
- GENERAL PARTNERSHIP
A general partnership is one of the most common kinds of legal entities in which two or more partners come together to run a business. In this partnership, all partners are responsible for the business, have unlimited liability for the company’s debts, and are liable for each other’s actions too. For instance, if one of the partners signs an agreement without the knowledge of the other, even then the other partner/s will also be obligated to follow the terms of the agreement in this kind of partnership.[2]
- LIMITED PARTNERSHIP
A limited partnership is a kind of legal entity which consists of at least one general partner who has unlimited liability, responsible to manage and make decisions for the business and a limited partner whose liability is limited to their investment amount, who is responsible for only investing in and not running or managing the business. In this kind of partnership, it is mandatory to have at least one general partner and one limited partner.[3]
- LIMITED LIABILITY PARTNERSHIP
A limited liability partnership (LLP) is a kind of general partnership in which all partners (two or more) have limited personal liabilities to the company’s debts to the extent of their investment/contribution to the business. In this kind of partnership, partners are not liable for the tortious damages of the other partners or creditors, and contrary to the limited partnerships, the partners can be limited liable while being able to take part in the management of the business.[4] In India, The Limited Liability Partnership Act, 2008 governs LLPs.
- PARTNERSHIP AT WILL
Section 7 of The Indian Partnership Act, 1932 states “Where no provision is made by contract between the partners for the duration of their partnership or the determination of their partnership, the partnership is “partnership at will”.[5] In this kind of partnership, there is no fixed time period for the duration of the partnership, and the partnership can come to an end when the partner serves notice to dissolve the partnership on the other partner/s if there is some provision in the partnership agreement.[6]
- PARTICULAR PARTNERSHIP
Section 8 of The Indian Partnership Act, 1932 defines the particular partnership. In this kind of partnership, any person can become a partner with another person for the purpose of one particular adventure or undertaking.[7] In this kind of partnership, if the partners want to continue the partnership, they can enter into an agreement. In case there is no such agreement signed, the partnership gets dissolved at the completion of the particular undertaking. [8]
- PARTNERSHIP FOR A FIXED TERM
When the partners fix the duration of the partnership during the agreement, it no longer remains the Partnership at Will. However, when the duration ends, the partnership also comes to an end. In such cases, if the partners continue the business and share the benefits, forming a mutual agency, it becomes a Partnership at Will.[9]
RISKS AND POTENTIAL RESULTS OF COMMERCIAL PARTNERSHIPS
Commercial partnerships are common to run businesses together but they come with various risks such as unlimited liabilities in case of financial mismanagement or company debts, legal risks and other operational challenges. When there are risks associated with commercial partnerships, they have their potential results arising out of them such as emotional conflict or compensation through personal financial assets. Some of the major risks and their potential results have been discussed in the current section of this research article.
- EXTENT OF LIABILITY OF PARTNERS: LIMITED OR UNLIMITED?
While in a sole proprietorship, the whole responsibility and liabilities involved in the business are on the single person, in commercial partnerships, all the partners have equal responsibility and unlimited liability for the business debts or other financial mismanagement in the business. In case, the partner is limited partner or the investor, the liabilities will be limited to the amount of their investment in the business as they do not have a say in the management or running of the business generally.[10]
When it comes to sole proprietorship and general partnership which is the most common and riskiest kind of partnership, partners have “unlimited liabilities”. While they enjoy the shared profits and the assets of their business, partners share the losses and debts of the business too. While the other partner’s actions or decisions are responsible for such situations, the remaining partners may be held liable for such actions or decisions of the other partners, which were made in connection to the business while being a partner.[11]
The Indian Partnership Act, 1932 in Section 25 also holds the partners liable for the acts of the firm, by stating, “Every partner is liable, jointly with all the other partners and also severally, for all acts of the firm done while he is a partner.”[12] This means that every partner will be jointly as well as severally (individually) liable for the acts of the business. If a company/business incurs losses and defaults to pay its debts, then the personal wealth and the financial resources of the partners can be seized to cover the debts, due to the unlimited liability of partners which makes them responsible for the business losses and debts. Consequently, this burdens their personal finances and assets.[13]
In Limited Liability Partnership, the liability of partners is limited. As per Section 28 of The Limited Liability Partnership Act, 2008, the partner is not personally liable for the wrongful act or omission of any other partner of the limited liability partnership.[14] However, in case of fraudulent acts by the partners, the liability is unlimited for all or any of the debts or other liabilities of the limited liability partnership as per Section 30 of The Limited Liability Partnership Act, 2008.[15]
- FUTURE SELLING COMPLICATIONS
There may be instances when one partner does not wish to continue the partnership business and sell the same to someone. This can cause a conflict as the other partner may not agree and want to sell their business. However, these situations can be dealt with by the inclusion of exit strategy clauses in the partnership agreement beforehand, for instance, to retain the “right to accept the offer” and “right to first refusal” when another partner decides to sell his/her interest in the business to a third party.[16]
- OPERATIONAL CONFLICTS AND CHALLENGES
In commercial partnerships, operational conflicts are common between the partners regarding profit sharing, exit provisions, distribution of resources, and decision-making due to the poor and mismanagement of resources, lack of coordination between the partners and non-clear provisions in the partnership agreement in respect of roles, responsibilities, rights, duties and liabilities of all partners.
MITIGATING THE RISKS OF COMMERCIAL PARTNERSHIPS
As discussed above, there are so many risks involved in commercial partnerships such as unlimited liabilities of partners, risk on personal financial resources, future selling complications and other operational challenges. To mitigate the risks, it is advised to include clear and relevant provisions in the partnership agreement (contract) agreed upon and consented by all partners to the partnership, to avoid all possible conflicts which may arise out of the partnership in future and also involve dispute resolution mechanisms in the same. The partnership agreement will help determine the clear structure of the partnership and decide the roles and responsibilities of every partner in the commercial partnership for the smooth functioning of the business.
In India, the Section 11 of The Indian Partnership Act, 1932 provides for the determination of rights and duties of the partners in the business via the contract by stating “….the mutual rights and duties of the partners of a firm may be determined by the contract between the partners, and such contract may be expressed or may be implied by a course of dealing.”[17] Though the agreement can be expressed or implied, it is always preferred and advised to have a written and expressed partnership agreement (contract) between the partnership to avoid any unnecessary hassle.
As The Indian Partnership Act, 1932 does not apply to Limited Liability Partnerships (LLPs.) in India[18], therefore in the case of the LLPs. in India, the partners need to sign the Limited Liability Partnership Agreement with the other partners or the LLP, which determines the mutual rights and duties of the partners and their rights and duties in relation to that limited liability partnership as defined in the Section 2(0) of The Limited Liability Partnership Act, 2008.[19] Therefore, it can be outrightly said that the partnership agreement plays an eminent role in determining the roles and responsibilities of the partners and deciding the extent of liabilities.
CONCLUSION
As above-mentioned, the commercial partnerships are of various kinds, such as general partnerships, limited partnerships, and limited liability partnerships on the basis of the extent of the liability of the partners involved in the respective partnerships, and on the basis of the duration of the partnership, there are partnerships at will, particular partnerships and partnerships for a fixed period. As commercial partnerships involve the sharing of the profits and assets of the company, it also puts unlimited liability for the debts and losses on the partners in certain instances which sometimes causes them to burden their own financial assets and resources. Apart from this, there are operational conflicts such as profit-sharing disputes or the mismanaging of resources also. However, these can be minimised if there is a valid partnership agreement in force consented by all the partners and contains relevant provisions for the avoidance of the possible conflicts of rights and duties of the partners.
[1] Section 4, The Indian Partnership Act, 1932.
[2] CFI Team, General Partnership, Corporate Finance Institute, available at https://corporatefinanceinstitute.com/resources/valuation/general-partnership/, last seen on 26/05/2023.
[3] Shweta and Brette Sember, What Is A Limited Partnership? Definition, Pros And Cons, Forbes Advisor, available at https://www.forbes.com/advisor/business/what-is-limited-partnership/#common_alternatives_to_limited_partnerships_section, last seen on 26/05/2023.
[4] Wex Definitions Team, limited liability partnership (LLP), Legal Information Institute, available at https://www.law.cornell.edu/wex/limited_liability_partnership_(llp)#:~:text=Limited%20liability%20partnership%20(LLP)%20is,debts%20depending%20on%20the%20state., last seen on 26/05/2023.
[5] Section 7, The Indian Partnership Act, 1932.
[6] Wright Hassall LLP-Kelly Schofield, Partnership Agreement v Partnership at Will, Lexology, available at https://www.lexology.com/library/detail.aspx?g=1498df20-afc0-4849-848b-003125d228bf, last seen on 26/05/2023.
[7] Section 8, The Indian Partnership Act, 1932.
[8] Particular partnership Sample Clauses, Law Insider, available at https://www.lawinsider.com/clause/particular-partnership, last seen on 26/05/2023.
[9] Indian Institute of Legal Studies, available at https://www.iilsindia.com/study-material/430215_1638168711.pdf, last seen on 26/05/2023.
[10] Mark Mikulasik, THE RISKS OF PARTNERSHIPS, Weilers LLP, available at https://weilers.ca/2022/06/27/the-risks-of-partnerships/, last seen on 28/05/2023.
[11] supra note 10.
[12] Section 25, The Indian Partnership Act, 1932.
[13] Evan Tarver, What Does Unlimited Liability Mean, and Which Businesses Have It?, Investopedia, available at https://www.investopedia.com/terms/u/unlimited-liability.asp, last seen on 28/05/2023.
[14] Section 28, The Limited Liability Partnership Act, 2008.
[15] Section 30, The Limited Liability Partnership Act, 2008.
[16] Bruna Martinuzzi, The Advantages and Disadvantages of a Partnership, American Express, available at https://www.americanexpress.com/en-us/business/trends-and-insights/articles/what-are-the-advantages-and-disadvantages-of-a-partnership/, last seen on 28/05/2023.
[17] Section 11(1), The Indian Partnership Act, 1932.
[18] Section 4, The Limited Liability Partnership Act, 2008.
[19] Section 2(o), The Limited Liability Partnership Act, 2008.
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