02. partnership

The question

When two or more persons wish to carry on a business together, the simplest form available to them is the partnership, the association of persons who carry on a business in common with a view to profit. The partnership advances beyond the sole trader by accommodating more than one owner, yet it shares with the sole trader the feature of unlimited personal liability in its basic form, and it introduces a new and important element, the mutual agency of the partners. This sub-unit examines the partnership, asking what constitutes it, how the partners relate to one another and to outsiders, what liability they bear, and how the basic form has been modified to limit that liability. The answer continues the module's ascent from the simplest forms toward the company, introducing the relations among co-owners that the company will also raise.

What constitutes a partnership

A partnership is the relation that exists between persons carrying on a business in common with a view to profit, and the elements of this definition determine when a partnership exists. There must be a business, an activity carried on; it must be carried on in common, by the persons together rather than by one alone; and it must be carried on with a view to profit, as a commercial venture rather than a charitable or social one. Where these elements are present, a partnership exists, and it may exist whether or not the persons intended to create one or called their relationship a partnership, since the law looks to the substance of the relation rather than to its label.

This feature connects to the principle, seen throughout the course, that the law characterises relationships by their substance. A partnership may arise informally, from the conduct of persons who carry on business together for profit, without any written agreement, though partners commonly regulate their relationship by a partnership agreement that sets out their respective contributions, shares of profit, and powers. In most traditions the partnership in its basic form, like the sole trader, has no legal personality separate from the partners, though some civil law systems and some specific forms do accord the partnership a measure of separate personality; the basic common law partnership is an aggregate of the partners rather than a person distinct from them. The substance of carrying on business in common for profit, and not the form or the label, is what brings the partnership into being.

Consider two individuals who together open and run a business, sharing its management and its profits, without forming a company or signing any agreement. They are carrying on a business in common with a view to profit, and they are therefore partners, with the rights and liabilities the law attaches to partners, whether or not they ever described themselves as such. Had they wished, they might have regulated their relationship by a written agreement, but the partnership exists from the substance of their dealing. The example shows the partnership arising from the substance of carrying on business in common for profit.

A partnership is therefore the relation between persons carrying on a business in common with a view to profit, arising from the substance of that relation rather than from any label or formality, and existing in its basic form as an association of the partners rather than as a separate legal person.

The mutual agency of partners

The element that distinguishes the partnership from a mere co-ownership, and that connects it to the previous module, is the mutual agency of the partners, the principle that each partner is an agent of the firm and of the other partners for the purpose of the business, so that each partner can bind the firm and the others by acts done in carrying on the business in the usual way. The partnership is, in this respect, an application of the law of agency examined in Module 03: each partner is simultaneously a principal and an agent, able to act for the firm and bound by the acts of the others.

This mutual agency connects directly to the analysis of authority in the previous module. A partner's power to bind the firm rests on the same principles of actual and apparent authority that govern agency generally: a partner binds the firm by acts within the authority the partners have conferred, and binds the firm to outsiders by acts within the authority a partner in such a business ordinarily appears to have, even where the partners have privately restricted it, protecting the third party who deals with the firm in good faith. The consequence is that the partners are bound by one another's commercial acts, and the trust this requires among partners is the reason the relationship is one of good faith, each partner owing the others a duty of loyalty in the conduct of the common business. The mutual agency makes the partnership a relation of considerable mutual exposure, since each partner places its position in the hands of the others.

Suppose one partner, acting in the ordinary course of the firm's business, makes a contract with a supplier in the firm's name. The contract binds the firm and all the partners, because the partner acted as agent of the firm within the authority a partner ordinarily has, even if the other partners knew nothing of the particular contract. Were the partner to act outside the ordinary scope of the business and beyond any apparent authority, the firm might not be bound. The example shows mutual agency binding the partners to one another's acts done in carrying on the business.

The mutual agency of partners is therefore the principle that each partner is an agent of the firm and the others, able to bind them by acts within the authority a partner ordinarily holds, an application of the law of agency that makes the partnership a relation of mutual exposure and good faith among the partners.

Liability in the general partnership

The mutual agency has a grave corollary in the basic form of partnership, the general partnership, namely the personal liability of the partners for the debts of the firm. Because the general partnership has no separate personality in the basic form, its debts are the debts of the partners, and each partner is liable for them, the liability being, in many systems, joint and several, meaning that each partner is liable for the whole of the firm's debts and a creditor may recover the whole from any one partner, leaving that partner to seek contribution from the others.

This liability connects to the analysis of unlimited liability in the previous sub-unit and intensifies it. The general partner bears not only unlimited personal liability for the debts of the business, as the sole trader does, but liability for debts incurred by the acts of the other partners through their mutual agency, so that a partner may be made to answer in full for an obligation another partner created. The combination of mutual agency and personal liability makes the general partnership a form of considerable risk, in which each partner's whole personal wealth stands behind the firm's debts, including those the partner did not personally incur. This intense and shared exposure is the principal disadvantage of the general partnership and the reason that forms limiting partners' liability were developed.

Imagine a general partnership that incurs a large debt, whether through the act of one partner or through the firm's general trading, and then cannot pay it from the firm's assets. A creditor may pursue any partner for the whole debt, reaching that partner's personal assets, and the partner so pursued must then seek contribution from the others. A partner may thus be made to pay in full for a liability arising from another partner's act. The example shows the personal, and joint and several, liability of the general partner for the firm's debts.

Liability in the general partnership is therefore personal and, in many systems, joint and several, each partner answerable in full for the firm's debts including those arising from the other partners' acts, a combination of mutual agency and unlimited liability that makes the general partnership a form of considerable and shared risk.

The limited partnership and the limited liability partnership

The risk of the general partnership prompted the development of partnership forms that limit the liability of some or all of the partners, and these connect the module to the principle of limited liability examined in its final sub-unit. The first such form is the limited partnership, which has two classes of partner: one or more general partners, who manage the firm and bear unlimited liability as in a general partnership, and one or more limited partners, who contribute capital and whose liability is limited to the amount they have contributed, but who must refrain from taking part in the management of the firm, on pain of losing their limited status. The limited partnership thus allows investors to participate in a partnership with their liability capped, while reserving management and unlimited liability to the general partners.

A more far-reaching form is the limited liability partnership, which limits the liability of all its members while allowing them to participate in management, combining the internal flexibility of a partnership with a limitation of liability resembling that of a company; in many systems the limited liability partnership has its own legal personality, distinct from its members. These forms connect to the trade-off that runs through the module, between the simplicity of the unincorporated forms and the protection of limited liability, and they represent intermediate solutions, retaining the partnership's character as an association of persons carrying on business together while mitigating, for some or all of the partners, the unlimited personal liability that the general partnership imposes. The availability and detail of these forms vary among jurisdictions, and a person choosing a partnership form must attend to what the governing law provides.

Consider investors who wish to contribute capital to a venture managed by others without exposing their whole wealth to its debts. A limited partnership accommodates them: they become limited partners, their liability capped at their contribution, while the managing general partners bear unlimited liability. Professionals who wish to practise together with limited liability while sharing management might instead use a limited liability partnership, in which all members enjoy limited liability and participate in management. The example shows the limited partnership and the limited liability partnership mitigating, in different ways, the unlimited liability of the general partnership.

The limited partnership and the limited liability partnership are therefore modifications of the basic form that limit the liability of some or all of the partners, the limited partnership capping the liability of passive investors while reserving management and unlimited liability to general partners, and the limited liability partnership limiting the liability of all members while allowing them to manage, intermediate forms between the unincorporated partnership and the company.