What is a Partnership Agreement? Definition, Clauses and Importance

The partnership agreement is defined as a written agreement between two or more individuals who have joined as partners in a partnership firm. It is a legally binding contract that state-specific terms and conditions of the working relationship.

The partnership agreement is signed by all the partners in the presence of a contract lawyer.

What is a partnership agreement?

The partnership agreement as the name suggests is a written agreement that is legally sound. A business relationship should be defined at the onset to avoid any disputes later on. The partnership agreement is binding for all the parties concerned and ensures that everyone is prepared for any change in ownership, death, and disputes between the partners.

It brings all the interested parties on the same page at the inception and continues to govern the relationship as dictated throughout the life of the partnership.

The partnership agreement is used profit-based business entities and should be detailed specifying every eventuality. It is important to take the help of an experienced business attorney who knows the in and out of partnership agreements. This will help in covering all bases and puts the partnership on the right foot from the beginning.

Importance of partnership agreement

It is important to have a partnership agreement in place because of the following reasons-

1. Roles and responsibilities

The partnership agreement is a detailed document that specifies the roles and responsibilities of all the concerned partners. There is clarity about the person who is going to be the managing partner, how the other partners are going to work and whether any of them have a special role and responsibility to fulfill.

2. The entry of new partners

Partnership agreement offers details about the circumstances when a new partner can enter the firm.

3. Dealing with partner issues

In order to deal with issues like conflict of interest, the partnership agreement can prove a blessing in disguise.

4. Agreement on important issues in advance

A partnership agreement allows partners to make decisions in advance. Everything is clear-cut so as to avoid any disputes. The agreement often includes a dispute resolution provision that needs mediation followed by binding arbitration.

5. Avoid liability issues

The partnership agreement is important because it spells out the liability of limited partners against general partners in a detailed manner.

6. Overriding state laws

If a firm has not signed a partnership agreement then it has to abide by the state laws which might not prove fruitful for your firm

7. Avoid issues about tax

The partnership agreement spells out in detail the tax status of the partnership and to illustrate that the profits are distributed on acceptable accounting and tax purposes.

8. Deal with changes

A partnership agreement is very important as it helps to deal with any changes in the future without challenging each other. When the terms are defined then it does not matter if a partner leaves a firm, is ill or even is dead.

9. Solving disputes

Partnership agreement proves an important piece of paper as it describes how to solve disputes.

10. Dealing with ownership issues

A partnership agreement offers details about the transfer of interest and restrictions on sales. It deals with ownership details and gives a clear picture of who owns what.

11. Removal of non-performing partner

At the onset, two or more than two individuals open a partnership firm with great interest. It is with the time that tells them whether the other is performing as per the required expectations.

In some cases, one of the partners does not work as expected and in that case, other partners may want to remove him. The written contract is important because it offers provision for the removal of a non-performing partner.

Clauses of the partnership agreement

It is imperative to keep in mind the various elements of partnership agreement while writing them so that it can pave the way to clear any misunderstandings in the future. The vital aspects of the agreement are-

• The partners in a partnership firm are owners of the business. It is not necessary that they will have equal share n fact the portion is pre-determined to avoid any issues later on.
• If you have formed a general partnership then it will not offer liability protection to the partners
• It is important to keep the partnership agreement simple and detailed so that every partner has a clear concept about handling any issues.

The important clauses include in a partnership agreement are

1. Name and address of every partner

Once people decide to open a partnership firm and become partners they will have to make a partnership agreement. The first thing that should be included in a deed is the names of the partnership firm, its address, the name of all the individuals who will act as partners and their address.

2. The term, duration or length of the partnership

The clause should state that the partnership is for a certain period of time or will continue for an unlimited time period.

3. Date of the commencement of the partnership

In order to create financial reports and deal with any legal issues, it is imperative to add the date of commencement of partnership in the deed

4. Purpose of the partnership

Clarifying the nature and purpose of the partnership does not leave any scope for personal interpretation in the future.

5. Capital contribution

The amount of capital contributed by every partner matters as it can act as a decisive factor in making important decisions. In some cases, the contribution is not equal and one partner offers more capital share and the other partner agrees to work more to compensate for less contribution. Include all the details in the deed.

6. Compensation, commission, salaries etc payable to partners

These are clauses that are included in the deed

7. Duties, rules, and responsibilities of every partner

Two or more people form a partnership company. An important clause in the written agreement is the details about how all the partners will be working and what will their role and responsibility in the firm are.

It also offers details about the kind of decisions partners can take by themselves and which decisions will need approval from all or the majority of the partners.

8. Rate of interest on drawings, loan, and capital

This clause avoids future misunderstandings

9. How to handle money

Who will be responsible for handling money and managing banking details for instance who will be signing company cheque ought to be included as a clause in the partnership agreement

10. Handling of legal problems

One of the clauses in the partnership agreement is about handling legal problems. It is vital to write it down the name of the partner who will be responsible for it.

11. Instructions on handling a situation where a partner dies or leaves the firm

The clause describes in detail the steps remaining partners can take in a situation where a partner leaves the firm or dies.

12. Capital contribution

Agree and record the capital contribution as it is an important clause of the written partnership agreement. It also states the ownership percentage of every partner

13. Handling income and the share of income of every partner

The allocation of profit as per the ownership percentage is the accepted norm in a partnership firm. Whatever the partners decide upon should be included in the deed to avoid any misuse

14. Loss percentage of every partner

An important clause is about the loss percentage of every partner. Is it the same as the profit-sharing percentage or different should be added in the clause beforehand.

15. How to deal with business debts

If a business incurs debts that will be responsible for it and what are the means that should be adopted to deal with the debts are part of the partnership agreement clause to make sure a single person does not become responsible for the debts.

16. Working hours

One of the clauses includes details about vacation, outside business activities and estimated working hours of every partner.

17. Mode of auditor’s appointment

Another clause is about the mode of auditor’s appointment

18. Withdrawal limits

The withdrawal limit puts a damper on the aspirations of any partner who is eager to withdraw a large sum of money from company funds.

19. Dispute resolution

When people are working together there is bound to be heated arguments at one time or another. Include a clause in the partnership agreement that spells out the way to solve issues that are deadlocked and details about the termination of a partnership

20. Payout details

Details about how one partner can buy out the other partner, succession planning in case of death of a partner and disposition of a partnership’s name if a partner leaves are important factors that need to be added as important clauses in a partnership agreement to avoid any issues later on.

The procedure of dissolution is complex and must be addressed after consulting with a business attorney. An important question that needs to be addressed is about share transfer and the nominees of the partners to whom the shares will be transferred.

21. Partnership registration

Once all the details are added in the partnership agreement make sure to register it. This will make it legal and official. Moreover, a registered deed gives the partners the power to file against co-partners, file suit against third parties and to claim set-off. It is only the registered partnerships that have the right to do so.