Partnership Law: Formation, Rights, Duties and Dissolution

A partnership is the simplest way for two or more people to do business together, which is why many small firms and professional practices use it. It is also one of the riskiest, because each partner can bind the others and every partner is personally liable for all the firm’s debts.

The law therefore gives a lot of attention to when a partnership exists, how it is run and how it ends.

This topic covers the general partnership. Limited partnerships and limited liability partnerships are in the next topic.

When does a partnership exist?

1. There must be a business. Business includes trade, vocation and profession, carried on by or on behalf of the partners. In Ikpeazu v ACB (1965) a solicitor who agreed with a debtor to supervise the debtor’s trading and pay the profits to the bank was held not to be a partner. Taking part in the running of a firm is not conclusive proof of being a partner.
2. There must be profit making and profit sharing. Without agreement to the contrary, profits and capital are shared equally. In Ugoji v Uzoukwu (1975) two people who each put ₦500 into buying books and agreed to share the books were held not to be partners, because they had agreed to share books, not profits.

Relationships that are not partnerships

Section 2(3) of the Partnership Act lists relationships that involve profits but do not make a partnership:

• receiving a debt or other fixed sum by instalments out of the accruing profits of a business;
• paying an employee or agent a share of profit as pay;
• paying an annuity to the widow or child of a deceased partner out of profits;
• paying an annuity out of profits in return for selling the goodwill of a business;
• joint tenancy, tenancy in common or other co-ownership of property, even if profits from its use are shared; and
• sharing gross returns.

Formation, the deed and membership

A partnership can be formed informally. It can arise from an oral or written agreement, or by default where people hold themselves out as partners. The ordinary law of contract decides whether the agreement is valid. A written agreement is called the articles of partnership, or a partnership deed if it is under seal.

Where the deed is incomplete, or there is none, the Partnership Act or the state Partnership Law fills the gaps.

Membership. Section 19 of Companies and Allied Matters Act (CAMA) limits a partnership for trade or general purposes to between 2 and 20 members. A larger one is an illegal association. A registered cooperative society, a partnership of qualified lawyers and a partnership of qualified accountants may each have more than 20.

A minor may become a partner, and the contract binds him unless he repudiates it before, or within a reasonable time of, reaching full age. If he repudiates, he is not liable for debts incurred while he was a minor.

Rights and duties of partners

In a general partnership all partners take part in management. The partnership has no separate legal personality and no perpetual succession, and partners are liable for all debts without limit. Every partner is an agent of the firm and of the other partners, so an act done in the ordinary course of the firm’s business binds them all.

If a partner has no authority for the particular matter and the other party knows it, or ought to know it, the firm is not bound.

Because each partner is an agent, each owes the duties to render true accounts and full information to the other partners, not to make secret profits and to account for any benefit gained from the firm’s property, and not to compete with the firm.

Dissolution

Without a court order

• Expiry or notice. A partnership for a fixed term ends when the term ends. One for a single venture ends with the venture. One for no fixed term ends when a partner gives notice to the others.
• Death or bankruptcy of a partner.
• Charge. If a partner lets his share be charged for his own debt, the others may dissolve.
• Illegality. An event makes the business unlawful.

By the court, on a partner’s application

When a partner is of unsound mind or permanently incapable, another partner is guilty of conduct that harms the business, a partner wilfully or persistently breaks the agreement or behaves so that it is impracticable to carry on, the business can only be run at a loss, or the court thinks dissolution just and equitable.

Effect and settlement

Dissolution ends each partner’s power to bind the firm, except to finish transactions already begun and to wind up the business. The property, including goodwill, is sold. If the assets fall short of the debts, the deficiency is met out of profits, then out of capital, and then by the partners personally in their profit-sharing ratio.

Assets are applied in this order: debts to outsiders; debts to partners who are lenders; each partner’s capital; and any surplus shared in the profit ratio.

An example

Ade, Bisi and Chidi share profits equally. On dissolution the assets sell for ₦4,000,000. Debts to outsiders are ₦2,500,000, Ade lent the firm ₦300,000, and capital accounts are ₦400,000 each (₦1,200,000 in all). After paying outsiders, ₦1,500,000 remains. Ade’s loan takes ₦300,000, leaving ₦1,200,000, which exactly repays the capital. There is no surplus.

Worked example: is there a partnership?

1. Test the elements. There is a business and a share of profit, but Musa receives profits only as repayment of a loan.
2. Apply section 2(3). Receiving a debt by instalments out of the accruing profits of a business does not make a partnership.
3. Check the other facts. Musa takes no part in running the business, which supports the same conclusion (compare Ikpeazu v ACB).
4. Conclude. There is no partnership, so Musa is not liable to the supplier as a partner.

Partnership law in more detail

The cases the syllabus uses

The default rules explained

• Equal shares. Equal sharing applies even where capital contributions differ. If Ade put in ₦800,000 and Bisi ₦200,000 and the firm made a profit of ₦300,000 with no agreement, each takes ₦150,000. Larger capital earns nothing extra unless the partners agree.
• Indemnity. If a partner pays a supplier out of his own pocket in the proper conduct of the business, the firm must repay him.
• Interest on advances. A partner who lends the firm money beyond his capital earns 5% a year.
  An advance of ₦500,000 kept for eight months earns 500,000 × 5% × 8 ÷ 12 = ₦16,667.
• No interest on capital and no salary. Capital and effort are rewarded through the shared profit unless the partners agree otherwise. A managing partner should have a written agreement for remuneration.
• Consent for new partners. Partners rely on one another’s honesty and solvency, so no one is admitted without every existing partner’s consent.
• Majority and unanimity. Ordinary matters are decided by a majority, but changing the nature of the business needs everyone, because it changes what each agreed to. If some partners contravene this, the others may ask the court to wind up the business.
• Expulsion. The majority has no power to expel a partner unless the agreement says so, because that would let the majority seize the firm.

The partners’ duties, explained

Because each partner acts as the agent of the firm and of the others, the Partnership Act gives him three duties. He must render true accounts and full information on everything affecting the partnership. He must make no secret profit, so that if he gains from using the firm’s property or connections he must account to the firm. And he must not compete with the firm.

A partner who secretly sells to a rival using the firm’s supplier contacts breaches the second and third duties.

Formation by holding out

A partnership can arise by default, where people hold themselves out as partners. A person who allows himself to be represented as a partner to a third party who relies on it may be treated as a partner for that purpose, even though there is no agreement among them. This is why a person who lends his name to a firm can become liable.

Dissolution, ground by ground

On dissolution each partner’s power to bind the firm ends, but partners may complete transactions already begun and do what is needed to wind up the business.

Partners’ authority, liability and the position of incoming and outgoing partners

Most problem questions on partnership ask whether the firm, or a partner, is bound by something one partner did. Work through the rules below in order.

1. Every partner is an agent of the firm

An act of a partner done in the usual way of carrying on the business of the kind the firm carries on binds the firm and the other partners. Authority may be actual, given by the partnership agreement or by the partners, or apparent, which means that a reasonable outsider would think the partner had it.

If the partner has no actual authority, the firm is not bound where the outsider knows he has no authority, or does not know or believe him to be a partner. This is the rule applied in ACB v Ndoma-Egba.

2. What is in the usual course depends on the kind of firm

So if one partner in a firm of tyre sellers borrows money from a bank to buy stock, the firm is bound, provided the bank had no notice that his authority was restricted. If a partner in a firm of accountants borrows in the firm’s name for a purpose that is not usual, the others are not bound, unless they authorised it.

3. Liability for debts and for wrongs

• For debts and obligations of the firm incurred while he is a partner, every partner is liable jointly with the others, and, after his death, his estate is liable so far as its assets allow.
• For a wrongful act or omission of a partner in the ordinary course of the firm’s business, or with the authority of the partners, the firm is liable to the same extent as the partner who did it.
• Where a partner receives money or property from a third party and misapplies it in the course of the firm’s business, the firm is liable to make good the loss.

4. Holding out

A person who represents himself as a partner, or knowingly allows himself to be represented as one, is liable as a partner to anyone who has given credit to the firm on the faith of that representation. This explains why a person who lets a firm use his name on its letterhead can be liable for its debts even though he has no agreement with the other partners.

5. Incoming and outgoing partners

6. Duties of good faith again, in problem form

A partner who secretly trades on his own account in the same line of business, or who takes a commission from a supplier of the firm, must hand the profit to the firm. A partner who uses firm property for private benefit must account for it. A partner who is dishonest can be sued by the others and may be a ground for the court to dissolve the firm.

A worked problem

1. The contract. Ade is an agent of the firm. If the purchase was in the usual course of the firm’s business, the firm and all the partners are bound and are jointly liable to the supplier, unless the supplier knew that Ade lacked authority.
2. Bola’s pay. Unless the partners expressly agree, no partner is entitled to payment for working in the business. Bola has no claim to a salary.
3. Chuka. No one may be introduced as a partner without the consent of every existing partner. Chuka is not a partner unless all agree, though if Bola held him out as a partner to creditors who relied on it, Bola and the firm may be liable to them.
4. Conclusion. The firm is liable to the supplier. Bola cannot claim pay or admit Chuka alone.

Questions that have been asked on this topic, and how to answer them

Common mistakes in the exam

• Treating any sharing of profit as a partnership. Section 2(3) lists exceptions.
• Saying a partnership needs a written deed. It can be formed informally.
• Forgetting that partners share equally unless they agree otherwise.
• Saying a partner is entitled to a salary. Only by express agreement.
• Forgetting the order in which assets are applied on dissolution.
• Treating the exceptions to the maximum of 20 as general.

Quick revision

• Partnership: a business, profit making and profit sharing. Six relationships are not partnerships.
• Formation: informal or by deed. Two to twenty members, with exceptions.
• Partners are agents. Equal shares, indemnity, 5% interest on advances, no pay, unanimity for new partners.
• Dissolution: expiry, notice, death, bankruptcy, charge, illegality, or the court.
• On dissolution: outsiders, partner-lenders, capital, surplus.

Practice questions

These are original questions written in the style of the Institute of Chartered Accountants of Nigeria (ICAN) exam. Try each one before you open the answer.

Section A style: multiple choice

Section B style: written questions

A further written question

Model answers

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