People who want to do business together often wonder what type of entity to use as a vehicle to do business in. The most common is a partnership.
In this article, we will discuss what a partnership is, how it works and what the implications are. Articles on other aspects include the actual workings of a business partnership and partnership taxation.
For Afrikaans version: Vennootskappe
Individuals as well as any other legal entity, namely Companies or Close Corporations, can enter into a Partnership. This means that two or more individuals can enter into a Partnership, or an individual(s) can enter into a Partnership with a Company or two Companies can enter into a partnership with each other. Normally, where two Companies enter into a Partnership, it is to work together to perform a specific job and at completion, the Partnership is ended. This is usually a “joint venture”.
A Partnership is entered into simply by signing an agreement that is specifically drafted for the Partnership. Such an agreement has certain requirements before it can be called a Partnership Agreement and before one can say that a Partnership has been established. It can be a verbal agreement as well. Apart from the South African Revenue Services, the Partnership does not have to be registered anywhere, like a Company, Close Corporation and Trust has to register at CIPCO.
A Partnership is not a separate legal entity, except for certain purposes. A Partnership is established by partners signing or entering into an agreement and that is why it is not a legal entity. If one of the partners dies, the Partnership dissolves. In fact, when anything in the Partnership changes then the Partnership comes to an end. A new partner cannot be allowed into the Partnership. If a new partner wants to join, the Partnership must be dissolved and a new Partnership agreement entered into. In terms of the Court rules a Partnership can be sued despite the fact that it is not a legal entity and for purposes of insolvency, a Partnership can be liquidated even though it is not a legal entity.
There are 5 requirements for a Partnership and they are the following:
a) There must be an agreement between the parties to form a Partnership. The agreement must state that the relevant parties are entering into a partnership with each other, by the signing of the Agreement. (It is not a requirement that the Agreement is in writing, but it is always much better to have every agreement in writing.); and
b) The parties must have the common goal to make a profit; and
c) Each partner must make a contribution to the Partnership and such contribution must be unconditional. This means that each partner must contribute either cash or labour or expertise and skills or some other intangible asset. The Partnership Agreement will state how much of what each partner will contribute, for example, Mr A will contribute R100 000 in cash and Mr B will contribute 30 hours of work per week working as a cashier. The amount and nature of each partner’s contribution does not have to be the same – one can contribute less and another can contribute more in accordance with the next requirement, namely
d) There must be a profit-sharing ratio. This means that it must be clear what and how much profit each partner will get. For example, A will be entitled to 51% of profits and B will be entitled to 49% of profits.
e) The Partnership must be carried on for the joint benefit of the partners.
Partnership types can vary because the partners can make any agreement with each other with regards to the workings of the Partnership.
There are two main types of Partnerships namely ordinary and extraordinary. Extraordinary Partnerships are either anonymous or en commandite. Anonymous Partnerships are Partnerships where the partners’ names are not disclosed to outside parties (people who are not partners in the Partnership). This means that extraordinary partners are not disclosed to third parties therefore third parties don’t know about them. The agreement between the partners in an Extraordinary Partnership will mean that the anonymous partner will only be liable towards the other partners as far as he must contribute either cash or labour or other assets and not toward third parties.
Extraordinary Partnerships that are en commandite is also referred to a Limited Partnership. The reason for this is that the partner that is en commandite is only liable to third parties to the same extent that he has contributed to the Partnership and not more. This means that, for example, where Mr X contributed R100 000 to the Partnership and he will, therefore, only be liable for the debt of the Partnership up to R100 000 and not more. The partner en commandite is also entitled to profits as determined in the Partnership Agreement. Where a Partnership is en commandite, normally the Partnership is carried on in the name of only one partner and the other partner(s) are not involved in the day-to-day running of the Partnership. The other
Partner(s) are also not disclosed to outside parties. The Partnership Agreement must be clear about these facts.
Ordinary Partnerships are the usual Partnerships where all the partners work and contribute to the Partnership together and are liable for the debt of the Partnership as per the Partnership agreement.
There are also what is referred to as Universal Partnerships. This is where parties lived and worked together and shared income and/or assets but did not get married. One can then argue that the parties formed a Universal Partnership, because the agreement between the parties, albeit silent, was one that complied with all five requirements of a Partnership. Read elsewhere in this article about the 5 requirements of a Partnership.
There is also a personal liability company as per Section 8 of the Companies Act. In the old Companies Act, these companies were called “Section 53 companies”. These types of companies are professional Partnerships (attorneys, architects or engineers) and these Partnerships work together. The name of the firm is ended by the abbreviation “Inc”, for example, Jones, Makalini Inc. (The Inc stands for Incorporated”). This type of company is in fact a Partnership although it is called a company. This type of company further allows for perpetual succession, meaning for example if there is a contract such as a lease agreement, the agreement can continue even if there was a change in the directors or shareholders of the company. The partners of this type of company can change, it is not like normal Partnerships where the Partnership comes to an end when one of the partners dies. Also, the directors and former directors of such a company are jointly and severally liable with the company for the debt of the company. Once a director leaves, he is no longer liable for the debt of the company incurred after he left, but he will be liable for debt incurred by the company whilst he was in office.
To fulfil the requirements of a Partnership Agreement, partners have certain duties which are listed below:
a) Each partner must contribute to the Partnership what he/she should as per the Partnership Agreement – this refers to the cash/labour/asset/skill that each partner must contribute;
b) Each partner must act in good faith towards other partners in accordance with a partner’s fiduciary duties. The fiduciary duty of a partner means that each partner will not compete with the business activities of the Partnership. This means that if, for example, the business of the Partnership is an ice cream shop, partner A should not open an ice cream shop in his own name across the street.
c) Each partner must avoid conflicts of interest;
d) Each partner must contribute to the losses of the Partnership in accordance with his/her liability as set out in the Partnership agreement;
e) Each partner must act with the necessary care when he/she is busy with the affairs of the Partnership – this includes that assets of the Partnership should only be used for the benefit of the Partnership.
Partners obtain certain rights when the Partnership Agreement is in place. Some of the rights are the following:
a) When the Partnership dissolves, each partner is entitled to a share of the assets of the Partnership in accordance with the Partnership Agreement;
b) When there are profits in the Partnership, each partner is entitled to his/her share of the profits in accordance with the Partnership Agreement;
The above are two of the main rights that a partner obtains in a Partnership. It is most important that it is clearly set out in the Partnership Agreement and what other rights and obligations are transferred to each partner.
It is very important that there is a written and signed Partnership Agreement. If there is not one, it will be very difficult to determine what each party is entitled to or obliged to contribute or to do, as generally, if a Partnership ends for another reason than death, there is usually bad blood and the partners have different versions of what was or was not agreed upon.
It is also not advisable to “copy and paste” an agreement from the internet. Rather consult a professional who knows how partnerships work. Rather spend a little bit of money up front to avoid problems later.
