Matt and John – An Accidental Partnership
Updated: Jan 12
The four main legal structures that business commonly use in the United Kingdom (UK) are as follows:
Limited Liability Partnership (LLP)
Sole Trader – A sole trader is someone who exclusively owns a business and is entitled to keep all the profits of the business. The advantages of this kind of business structure are its low cost, easy set up, and the fact that the trader has full control of the company and minor financial reporting responsibilities. The main disadvantage of this kind of legal structure is that the trader is fully liable for the debts of the business.
Limited Company – A limited company is a private company where the owners' liability is limited to a fixed sum, usually to the extent of the amount of capital they invest. If a limited liability company is sued, then the claimants are suing the company, not its owners. The advantages of this kind of structure are less personal financial exposure, a favourable tax regime and the ability to work for corporate clients. The disadvantages are the heavy administrative and regulatory demands and the obligation to file accounts, annual returns and financial reports on the Companies House register. This is the most commonly used structure in the UK.
Limited Liability Partnership (LLP) – A limited liability partnership is formed between two or more individuals but in terms of liability each partner is liable to the extent of capital invested.The advantages of this kind of structure are similar to those of a limited company and includes the flexibility to incorporate members in a member’s agreement. The disadvantages are that profit is taxed as income, partners must disclose their income and the LLP must start trading within a year of registration or be struck off.
General Partnership – This form of legal structure is different from a LLP partnership. This is the default business structure for two or more people who operate a business together. Time and time again people start businesses thinking they have no contractual obligations or other legal obligations because there is no written agreement. That's where they are wrong.
The Partnership Act (PA) 1890 governs partnerships. Section 1 of the PA 1890 defines a partnership as a relationship where two or more people start a business with a common view of making profit. Section 9 of the PA 1890 provides for joint liability in a partnership.
Problems start arising when there is no legal structure but partnerships are created inadvertently. Two issues that frequently arise in a partnership are firstly, liability when the business fails and secondly entitlement to profits of the business when the business is doing well.
Matt (an electrician) and John (an IT whizz kid) were best friends for 10 years. One day they decided they wanted to start their own IT firm. They both put money into the business. Matt put more money into the business, but John used his technical skills and knowledge for the business. They did not have any contracts or agreements regulating their business. The business was doing well but then one day the business went bust due to clients not paying on time. John decided to leave the business and let Matt take on responsibility for the debts. John did not think he had any obligation to help Matt as they had not signed any contract or agreement.
However, John and Matt started the business together with a view of making profit. Even though Matt had put the bulk of the money into the business, John used his skills and knowledge to set up and build the business. Under the Partnership Act 1890 both partners are liable for the partnership's debts.
In some situations, some people might use partnerships as a means of getting profit. This is illustrated in the case of Ilott v Williams and others [7 June 2013]. In this case four friends had agreed a business idea, they had meetings, obtained an internet domain name and had prepared various presentations and proposals. However, none of them gave any thought to the type of legal structure they wanted. When the relationship later broke down, one of them argued that a partnership had come into being and that he was entitled to some of the profits as a partner.
The Court was of the view that this was not enough to amount to carrying on a business with a view of profit. This was based on the assessment of what the four had done and how they regarded each other. They court also considered that the steps they had taken towards the future operation of the business (eg acquiring a web domain name) were insufficient. The four friends were still in the early stages of discussing sources of funding and had not financially committed to the business or entered into a business agreement. At that stage, all they had was the business concept, not the means of creating any profit.
Although this case fell short of a partnership, the formation of preparatory steps to starting a business can be sufficient to create a partnership. The courts will always look at the facts and decide each case on its own merits.
Starting a business is exciting. Even if you are setting up a business with your best friend or a member of your family, always take legal advice about your particular situation before setting up the business and always have contracts or agreements in place. Your lawyer will be able to advise you on which business structure is best for your circumstances.
Pure Business Law drafts contracts and agreements for people wishing to set up a business. We have drafted contracts for numerous start-ups, entrepreneurs and businesses in various industries including the tech,finance,hospitality and construction industries. We provide fixed fee legal services which give clients peace of mind and certainty in an uncertain world.
Contact us today by phone on 01234 834620/834621 or email at email@example.com and see how we can help your business become more successful.
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Nazish Farooq is a Legal Intern at Pure Business Law. She has a LLB (Hons) Law. She is currently studying the Legal Practice Course (LPC) at the University of Law. Nazish splits her time between studying and working. In her spare time she likes reading and keeping herself active.