A partnership requires rules that will govern the partners’ relationship.
A partnership simply comes into being when two or more persons carry on business together with a view to make a profit. A partnership is like a proprietorship because partners carry on the business directly and the partnership is not considered a legal entity that is separate from its partners. This has some consequences:
- A partner is personally liable for debts, obligations, and liabilities of the partnership.
- A partnership dissolves if one of its partners quits or dies (in the absence of an agreement to the contrary).
- A partner cannot be an employee of the partnership or its creditor because the partner cannot make a contract with him- or herself.
- A partnership is not taxed as a separate entity on its net income. Although the income or losses from the partnership business is calculated at the firm level, it is allocated to the partners and included as part of their personal income in their own returns.
In Ontario, there are three types of partnerships:
- general partnerships;
- limited partnerships; and
- limited liability partnerships (LLPs).
Most partnerships are “general” partnerships, in which liability is unlimited, and all benefits and debts are the partners’ personally. These partnerships do not need to be registered. The limited partnership requires special registration. In a limited partnership, the liability of one or more of the partners is unlimited, and the liability of one or more of the other partners is limited to the amount which those partners contributed to the business. LLPs are a cross between general partnerships and limited partnerships and are typically used by groups of professionals. In an LLP, the assets of the firm are available to satisfy debts and claims against it, but partners are liable only for their own negligence or the negligence of employees under their direct supervision and control.
A Partnership Agreement
A partnership requires rules that will govern the partners’ relationship, spelling out each of the partners’ rights and responsibilities. Such rules can be found in the conduct of the parties or in a contract created by the partners called a partnership agreement. Before drafting such an agreement, the partners should ask the following questions (the list is non-exhaustive):
- How will profits be shared and how will loses be allocated?
- Who will have signing authority?
- What will be the address of the firm?
- Which partner(s) will be able to participate in the management of the business?
- How can a partner be expelled?
- How many votes are required to admit a new partner?
- Is a partner entitled to interest on his or her capital?
- How is the partnership terminated?
If the partnership agreement is silent on an issue, the issue will be governed by the Ontario Partnership Act (the “OPA”).The OPA contains default rules that govern the relationship of the partnership. In addition to these optional rules, the OPA has mandatory rules that govern how a partnership may act with those outside of the partnership itself.