Why does my farming business need a written Partnership Agreement?

From Limited Companies to LLPs, there are many different structures under which a family farming business may operate. The most commonly encountered in practice is the family farming partnership, which requires none of the formality needed to set up other more regulated business structures, but simply for the statutory definition in section 1 of the Partnership Act 1890 to be satisfied.

Section 1 defines partnership as a “relation which subsists between persons carrying on a business in common with a view of profit”. It is a very broad definition and it is feasible, if rare, that individuals may find themselves in a partnership without ever having putting their minds to it. Being a partner in a partnership brings with it unlimited liability for partnership debts, and the power to bind other partners by acts or omissions (or be bound by the acts or omissions of the other partners), so the risk of a partnership being formed should be taken seriously.

The Partnership Act 1890 (“the 1890 Act”) remains the relevant piece of legislation, and will apply to all partnerships unless it is dis-applied by agreement – which can be written or oral – between the partners. For evidential reasons a written partnership agreement is almost always advisable.

The 1890 Act

The 1890 Act is a concise piece of legislation, which inevitably does not cover all circumstances or eventualities that may be relevant to a farming business. Some provisions can, if not dis-applied or varied by written agreement, have unintended and potentially expensive consequences for the individuals involved.

A prime example is the situation on the death of a partner. Under the 1890 Act, when a partner dies the partnership will automatically dissolve. This can have catastrophic consequences for the business and the partners, particularly if the family farm is held as an asset of the business. On dissolution there should be a cessation of the partnership business, settlement of all partnership liabilities and payment to the partners of what is due to them, to reflect their capital interest in the business. Where there is insufficient cash to cover such payments this can result in the partners having no choice but to sell all or part of the family farm.

Similarly, with no written partnership agreement in place, any partner can call for a dissolution at any time by serving notice on the other partners. This will almost always be a provision that a written partnership should at least vary, if not remove entirely.

What should a written partnership agreement cover?

The issues outlined above can be avoided by the partners signing up to a written partnership agreement. As well as dis-applying the unhelpful elements of the 1890 Act, the written agreement should also cover eventualities not anticipated by the legislation. There is no one size fits all approach to a written agreement, as each business is as unique as the family running it, and so bespoke drafting is always required.

As a minimum, a written partnership agreement should cover the following:

• Capital – what assets form the capital of the business, and how and in what shares have they been contributed by the partners? This will be crucial to determining a partner’s share in the business in the event of death, retirement or dissolution.
• Land and assets – is the farm held as an asset of the partnership, or just used by it by permission of the landowning partner? How are capital profits in relation to that land to be shared, how should any losses be dealt with and should there be land capital accounts ring-fencing profits and decisions in relation to the land to certain partners? The inheritance tax position of landowning partners should also be considered.
• Profits and losses – how are the partners going to share the profits from the farming trade? The 1890 Act provides for equality between the partners, but does that reflect the intentions of the partners?
• Duties and authority – the duties of the partners can be set out in detail to ensure all parties are aware of, and meet, their responsibilities, and outline what will constitute a breach which may lead to sanction by the partnership. Meeting and voting procedures will also likely be included, and any number of voting mechanisms can be considered to suit the realities of the partnership.
• Disposal/retirement/death – the agreement will usually dis-apply the relevant 1890 Act provisions (as detailed above), in particular by stating that the death of a partner will not automatically dissolve the partnership. The agreement can include provisions that allow partners to dispose of their shares in the partnership – including in respect of any land held by it – on death or on a retirement from the partnership.
• Disputes and expulsion – provision should be included to allow for disputes to be resolved without the need to resort to court action. There may also be a provision that allows partners to expel a partner who has committed a serious breach of the agreement.

Tax benefits

There are a number of tax benefits available that can make having a written partnership agreement important for any family farming enterprise.

Agricultural property held by a partner will hopefully attract Agricultural Property Relief (“APR”) from inheritance tax on the death of that partner. However, APR only covers the agricultural value of the relevant property, so to the extent there is non-agricultural value attached (such as development value, buildings used for commercial lets or residential properties), APR will not apply and that value will be exposed to inheritance tax.

Such value can however qualify for 100% business property relief (“BPR”) if the property is, and has been for the requisite period, held as an asset of the partnership, and the partnership business is wholly or mainly trading. A written partnership agreement can therefore provide crucial evidence of what assets are held within the partnership to support a claim for BPR and reduce the exposure to inheritance tax.

If you are interested in written partnership agreements, or would like to have your agreement updated, please get in touch with Leo McMahon on [email protected] or 01603 542711 or one of our other farming partnership specialist