A Partnership Litigator’s FAQs

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A Partnership Litigator’s FAQs

By Jeremy Callman, Ten Old Square Having litigated partnership disputes of all shapes and sizes over many years, the same issues often raise their (usually very hot) heads. I hope that these FAQs will provide some useful pointers. That said, it is important to bear in mind that in 9 out of 10 (if not 99 out of 100) cases, the outcome turns on the facts.

Any lawyer who proposes a ‘one size fits all’ response, should swiftly be shown the door. Therefore, the word “answer” below should be construed liberally as meaning “a general indication of the key points to be taken into account and carefully applied to the individual facts”!

The thoughts below are no replacement for the taking of careful and fact specific legal advice.

Q: “Who should sue and be sued in a partnership dispute?”

A: We need to distinguish between a traditional1 partnership and a Limited Liability Partnership (“an LLP”). As all readers will be a well aware, a traditional partnership is merely a collection of individuals (the partners) carrying on a business together with a view to making profit2; it is not a separate legal entity.

So a claim should be brought by or against those who were the partners at the time the cause of action accrued.

This in turn will require a careful analysis of when the cause (or causes) of action accrued. CPR 7APD para 5A.3 states that “where that partnership has a name, unless it is inappropriate to do so, claims must be brought in or against the name under which that partnership carried on 1

Jeremy Callman Ten Old Square

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business at the time the cause of action accrued.” Thus the use of the firm’s name in proceedings is a useful shorthand for those who were partners at the time the cause of action accrued. Any party to a claim may3 however request a partnership membership statement, setting out the names and last known places of residence of all persons who were partners at the time the cause of action accrued.

It is also important to have in mind that people may be held out as partners to the outside world, but actually not be partners. The acts of a person merely held out as a partner4 are very likely to bind the partners (see s.6 Partnership Act 1890); however that person merely held out as a partner is not actually a partner, nor is he5 usually properly a party to proceedings against the partners or brought by the partners.

Megarry J’s helpful analysis in Stekel v Ellice [1973] 191 (at 199G-H) is always useful to have in mind: “What must be done, I think, is to look at the substance of the relationship between the parties; and there is ample authority for saying that the question whether or not there is a partnership depends on what the true relationship is, and not on any mere label attached to that relationship.” What matters is what’s in the bottle, not the label on the bottle.

For an LLP the position is far simpler.

Given that the LLP is a separate legal entity, in most cases6 the claim will be brought by or against the LLP7.

Also called “a general partnership” or “an 1890 partnership” and sometimes “an old style partnership”.

2 S. 1(1) Partnership Act 1890.

CPR 7APD para 5B. Often referred to as “salaried partners”, but this is not a term of art.

5 Please treat “he” as standing for “he/she” on all occasions.

6 There will, of course, be some cases where individual members are properly parties to proceedings, but given that the very purpose of an LLP is in large part to avoid personal liability, this is not common.

7 Readers may find of further assistance, the far fuller analysis set out in the PLC Practice Note jointly written by me and my colleague Naomi Winston, entitled “Practical tips and traps in partnership and LLP litigation”.

3 4

A Partnership Litigator’s FAQs Continued...

Q: “Is this property partnership property?”

A: The key distinction is between: (a) property which is personal8 property held outside the partnership but used by the partnership and (b) partnership property. An example will help make the point. Let us take a farming partnership. Two neighbouring farmers each own a field. They decide to go into partnership. They could retain their respective fields as personal property held outside the partnership but merely farm the land together in partnership.

The crops grown on the fields would be partnership property but not the fields themselves. By contrast they could agree to bring their respective fields into the ‘partnership stock’. The fields themselves (as well as the crops grown on them) are partnership property.

The difference is important. If the partnership is dissolved and wound up and the fields are partnership property then they will be sold and their value will be used first to pay off liabilities etc.

What remains of the value of the fields will be distributed in accordance with the partnership agreement or if there is no partnership agreement (or the partnership agreement does not deal with this) in accordance with section 44 of the Partnership Act. If the property is personal, it will remain outside the dissolution and winding up process9.

To answer the question, the first place to look is any written partnership agreement which will hopefully identify what is and is not partnership property.

There may be an express declaration of trust in some other document, making it clear how the property is held. If not, then one turns to trying to identify an oral agreement as to what property will or will not be partnership property.

If there is no express (written or oral) agreement then answering the question will turn on trying to ascertain the implied agreement or the partners one way or the other. This is a mixed question of fact and law. Some of the key points one would want to consider are:

property. For an LLP, property will usually be owned in the name of the LLP which would usually make it clear that it is LLP property. It could be that a member holds property on trust for the LLP (or indeed that the LLP holds property on trust for an individual member) but that is likely to be more unusual.

(a) W hat do any documents say or suggest? If the acquisition post dates the formation of the partnership then documents from the time the property was acquired (eg conveyancing solicitor’s file) will be especially important. If the acquisition pre-dates the formation of the partnership then one would look carefully at documents in the run up to formation of the partnership, which may indicate what each partner was bringing in to the partnership at the outset;

Q: “Can I get an injunction?”

(b) W hat money was used to buy the property? If it was partnership monies then that is a strong pointer towards it being partnership property10.

(c) How is the property treated in the partnership accounts?

(a) is there a serious question to be tried (if the person applying for the injunction fails to satisfy the court of this then the application will fail);

(d) Then look for all and any other pointers (references in documents, how repairs were paid for, oral evidence, how property was dealt with in wills, how property was dealt with for tax purposes, how the property (if it is land) is recorded at HMLR etc).

For LLPs, the uncertainty is likely to be less. In a traditional partnership the property will be held in a partner(s) name which leaves open the question of whether that partner (or those partners) hold it personally or as partnership

A: The immediate answer is to ask another set of questions: “an injunction to achieve what and in what circumstances? Injunctions are either final (awarded at trial) or interim (award to ‘hold the ring’ between now and trial).

The question is most commonly asked in the context of interim injunctions. The general principles that apply for interim injunctions apply equally in the context of partnerships. One needs to apply a three stage test:

(b) if the first hurdle is jumped, then would damages be an adequate remedy (if the answer to this is that damages would be an adequate remedy then an interim injunction will not normally be granted);

(c) if the first and second hurdles are jumped then the court goes on to ask where the balance of convenience (pending trial) lies.

The principles are common to LLPs and partnerships. Anyone considering an application for an interim injunction should bear firmly in mind that the court is not there to nanny or police the day to day running of the partnership. When deciding whether to grant an injunction,

8

Sometimes referred to as ‘separate’ property.

9

Although given that partners are personally liable, all the personal assets of each of the partners may be called upon to meet personal liabilities.

10

See s.21 PA 1890.

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A Partnership Litigator’s FAQs Continued... the court will be reluctant to hold a mini-trial and will strive to find a way of preserving the position until it can get to the bottom of the issues at trial, without being unfair to either side. The court may feel it better to order a speedy trial than an injunction (or in some situations both, so as to minimise the potential adverse impact of the injunction). A court will usually be more reluctant to put in place an injunction requiring something to be done (a mandatory injunction) than an injunction stopping something being done (a prohibitory injunction). Do not forget also that the party seeking the injunction will usually be required to give a cross undertaking as to damages11. The court will not usually force someone to perform a contract for personal services12, so an injunction requiring a partner to return to his desk is unlikely. More common is an injunction preventing him starting work for another firm pending trial.

Where a firm has expelled a partner and that partner is challenging the expulsion, the firm is unlikely (save in exceptional circumstances) to be forced to take back the partner pending trial. Remember also that delay is likely to reduce the prospects of being granted an interim injunction.

The procedure for applying is carefully set out in CPR 25 and 23. There is good commentary in the White Book sections for those parts of the CPR and also the well buried section 15 of the White Book Volume 2.

Q: “Do members of an LLP owe each other duties of good faith?”

A: The duty of good faith owed between partners in a traditional partnership is the very bedrock of a traditional partnership. Not so (or not necessarily so) for an LLP. The first place to look

is the LLP agreement. That may well include an express (contractual) duty of good faith owed by members to the LLP13. It may even expressly state whether members do or do not owe each other duties of good faith (although that is less common to find included in the agreement).

In some situations, duties of loyalty and good faith may be implied into the LLP agreement, applying the usual principles of implying terms into contracts14.

Assuming the LLP agreement is silent about the position member to member and no duty can be implied, what then? As is made clear in the gigantic judgment in F & C Alternative Investments (Holdings) Ltd v Barthelemy [2012] Ch 613, members of an LLP do not automatically owe other members a duty of good faith (see paras 207- 210 of the judgment). In some situations members will be acting as agent of the LLP (per s.6(1) of the Limited Liability Partnerships Act 2000), but whilst that is likely to lead to the member owing the LLP fiduciary duties (an agent will usually owe his principal fiduciary duties) that does not mean he will owe the other members such duties.

The test that Sales J applied throughout his judgment (adopting the approach of the House of Lords in White v Jones [1995] 2 AC 207) was: “Fiduciary obligations arise from particular circumstances, where a person assumes responsibility for the management of another’s property or affairs.” Whilst that gives a helpful general test, it necessitates a fact specific analysis to ascertain what, if any, fiduciary duties apply. This is likely to present very considerable difficulty in the realm of conflicting roles, where for example a corporate member acts with two hats on

(member of the LLP and corporate entity acting on behalf of its own shareholder interests).

Q: “Mr X is a 25% partner - does he own 25% of the assets?”

A: No! In the context of a general partnership one cannot improve on the hugely helpful passage of Nourse LJ in Popat v Shonchhatra [1997] 1 WLR 1367 at 1372C-E: “Although it is both customary and convenient to speak of a partner’s “share” of the partnership assets, that is not a truly accurate description of his interest in them, at all events so long as the partnership is a going concern.

While each partner has a proprietary interest in each and every asset, he has no entitlement to any specific asset and, in consequence, no right, without the consent of the other partners or partner, to require the whole or even a share of any particular asset to be vested in him. On dissolution the position is in substance not much different, the partnership property falling to be applied, subject to sections 40 to 43 (if and so far as applicable), in accordance with sections 39 and 44 of the Act of 1890. As part of that process, each partner in a solvent partnership is presumptively entitled to payment of what is due from the firm to him in respect of capital before division of the ultimate residue in the shares in which profits are divisible: see section 44(b). It is only at that stage that a partner can accurately be said to be entitled to a share of anything, which, in the absence of agreement to the contrary, will be a share of cash.”

For an LLP the answer is still no! The LLP owns the assets. The member is only entitled to a share or interest in the LLP.

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long the lines of: “if the court later finds that this order [ie the injunction] has caused loss to the respondent and decides that the respondent should be compensated for that loss, the applicant will A comply with any order the court may make”. This may well put some potential applicants off applying. The person applying will usually need to provide evidence that he is good for the money and could meet the cross undertaking.

12

Whether that be a singer (Lumley v Wagner (1852) 1 De GM&G 604) or a boxer (Warren v Mendy [1989] 1 WLR 853).

13

Such a provision is commonly found in LLP agreements.

14

See AG of Belize v Belize Telecom Ltd [2009] 1 WLR 1988 for a helpful summary of the principles.

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A Partnership Litigator’s FAQs Continued...

In much the same way, until the LLP is wound up and distributes its net assets, a member cannot claim to be entitled to a share of any particular asset owned by the LLP. Q: “We hate Mr X but don’t have ground to expel him and there is no power to compulsorily retire him, can we just shut down the firm and start up without him?”

A: Again no! Terms for the departure of Mr X may be agreed (typically by way of a deed of retirement). Usually what is agreed is that Mr X will leave the partnership or LLP in exchange for a payment (immediate or – more commonly – over time) and indemnities;

Mr X’s ‘share’ of assets remain with the firm which continues15 without him.

If terms cannot be agreed and there is no power to expel or compulsorily retire Mr X, then the firm is often left in an invidious position. The partnership or LLP agreement may include a power (usually by a substantial majority) to dissolve (for a traditional partnership) or wind up (for an LLP). If it does so then that may trigger some unpleasant consequences (eg banks calling in loans, issues with regulators, landlords, insurers, employees and so forth). If all else fails, in the context of a traditional partnership, the court may order a dissolution under s.35 Partnership Act 1890 (which includes the often helpful

sections 35(d) and (f )).

Once a partnership is dissolved or an LLP wound up, the majority partners cannot simply take for themselves the assets of the firm and start up again without Mr X. There must be an account taken under which Mr X is paid out his share.

The other partners can then start a new partnership or LLP, without Mr X, using their own shares of the net assets or the firm. In reality this process is likely to be highly disruptive, expensive and potentially damaging to the financial interests of the firm. For this very reason (among others) well drafted partnership and LLP agreements will include a power of compulsory retirement16.

15

For a traditional partnership there is a technical dissolution whenever the partners change. A technical dissolution does not however result in the winding up of the firm.

16

E ven then, the use of such clauses is not without potential attack principally for (a) a failure to follow procedure stipulated in the agreement, (b) bad faith/abuse of the power and (c) a breach of the Equality Act 2010.

“

Can I get an Injunction?

The procedure for applying is carefully set out in CPR 25 and 23. There is good commentary in the White Book sections for those parts of the CPR and also the well buried section 15 of the White Book Volume 2.

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