Importance of Partnership Agreement

by David Carnes
Even a handshake is enough to create a legal partnership.

Even a handshake is enough to create a legal partnership.

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A legal partnership is formed automatically whenever two or more parties -- either individuals or organizations -- agree to do business together and share profits and losses. Partnerships are governed by state law, and these laws vary somewhat from state to state. You don't need to register your partnership with the state government for partnership law to apply.

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Types of Partnerships

Two traditional types of partnerships are possible -- general partnerships and limited partnerships. In a general partnership, all partners face unlimited personal liability for business debts. In a limited partnership, some partners act as passive investors -- they don't take part in day-to-day business decisions, and their liability for partnership debts is limited to the amount they invested. Limited partnerships are formed through registration with the state government. In recent decades, states have also created other types of partnerships, such as limited liability partnerships (LLPs) and limited liability companies (LLCs). These types of partnerships offer some form of limited liability to all partners.

Legal Status of Partnership Agreements

Forming a partnership does not legally require execution of a partnership agreement. If you don't execute an agreement, however, the default rules of state partnership law will govern your partnership. Default rules are laws that apply only if there are no contrary provisions in a partnership agreement. State partnership laws also contain mandatory provisions that apply regardless of the terms of a partnership agreement. For example, partnership law does not allow a limited partner to take an active role in managing the business, and any contrary provision in a partnership agreement cannot be enforced.

Advantages

A partnership agreement can override state default rules in a manner that suits the partnership's business needs. For example, a default rule may state that all partners are entitled to profits in proportion to their investment in the partnership. A partnership agreement, however, may allow a partner with particularly valuable expertise to receive a greater proportion of profits than he would receive under state default rules. Although partnerships generally dissolve if even one partner leaves or dies, a partnership agreement may clarify how a partner may leave the partnership without dissolving it. For example, it may include buyout provisions that apply whenever a partner wishes to withdraw from the partnership.

Contents

A comprehensive partnership agreement should include provisions governing the departure of partners, the addition of new partners, the allocation of profits and losses among the partners, and partner capital contributions. It should list the responsibilities and voting rights of each partner and should state which partners have the authority to legally bind the partnership with their signatures. It should also clarify the partnership's business goals and state how disputes are to be resolved (through arbitration, for example). The agreement should be broken into sections based on topic. One section might deal with partnership governance, for example, while another might be devoted to changes in membership.