Scottish Law Commission (Reports)

PART II

A SUMMARY OF THE CURRENT LAW

Introduction

2.1     This Part seeks to set out the basic structure of partnership law, which we discuss in more detail in this report. The Partnership Act 1890 forms the basis of partnership law in the United Kingdom. But the 1890 Act is a basic code and the rules of common law and equity relating to partnerships continue to play an important role in the law of partnership.

A contractual relationship

2.2     A partnership depends upon an existing relationship which results from a contract. The contract is, as Jessel MR explained in Pooley v Driver:^[1]

A contract for the purpose of carrying on a commercial business – that is, a business bringing profit, and dividing the profit in some shape or another between the partners.

2.3     A partnership relationship can arise only by mutual consent, which may be express or inferred from parties' conduct. The personal nature of partnership means that a partner has agreed to associate with his co-partners and no-one else: no new partner can be introduced without the consent of all the partners.
2.4     Notwithstanding the contractual origin of a partnership, it appears that once in being a partnership is not governed solely by the rules of contract law. In Hurst v Bryk,^[2] Lord Millett has suggested that, in English law, a partnership is more than a simple contract; it is a continuing personal as well as commercial relationship. He has argued that the Court of Chancery controls this relationship and that the Court has a discretionary power under section 35 of the 1890 Act to dissolve a partnership. As a result he suggests that repudiatory breach of contract by a partner is not a ground for the automatic dissolution of a partnership. Since then, Neuberger J has adopted Lord Millett's reasoning in reaching judgment in Mullins v Laughton.^[3]

Partnership and legal personality

2.5     In English law a partnership is not an entity separate and distinct from the partners who at any time may compose it. The firm cannot acquire rights nor can it incur obligations. A firm cannot hold property. The rights and liabilities of a partnership are the collection of the individual rights and liabilities of each of the partners. The firm name is a mere expression, not a legal entity.^[4] We call this the "aggregate" approach to partnership.^[5]
2.6     Any change in the membership of a firm, whether the withdrawal of a partner or the admission of a new partner, "destroys the identity of the firm".^[6] The "old" firm is dissolved. If the surviving partners continue in partnership (with or without additional partners) a "new" firm is created. The new firm can take over the assets of the old one and assume its obligations. This involves a contractual arrangement between members of the old firm and the new firm, to continue the old firm's business. In addition, the transfer of an obligation will normally require the consent of the creditor. Continuing a partnership's business in this way does not continue the partnership itself. Even an agreement in advance that partners will continue to practise in partnership on the retirement of one of their number does not prevent the partnership which practises the day after the retirement from being a different partnership from that in business on the previous day.^[7]
2.7     In Scots law, "a firm is a legal person distinct from the partners of whom it is composed".^[8] A partnership is able to own property,^[9] hold rights and assume obligations. It can sue and be sued.^[10] It can be a partner in another partnership. It can have a partner in common with another partnership while remaining separate from that firm, and can also be its debtor or creditor. A partnership can enter into contracts with its partners, who can thus be creditors or debtors of the firm.
2.8     There is serious doubt as to whether the legal personality of a Scottish partnership can continue on a change in the composition of the partnership. On one view, in contrast with English law, partners can agree that a partnership will continue on a change of membership and thus the legal personality of the firm continues. On the other view, even where partners agree that the partnership is not to be dissolved on a change of membership, any alteration in the composition of the partnership gives rise to a new legal personality. On the latter approach the law in both jurisdictions does not allow continuity of partnership, making partnership a less stable business relationship than it might be.
2.9     English law has maintained the "aggregate" approach to partnership: the name of the firm is, subject to certain exceptions which we discuss below,^[11] no more than convenient shorthand for referring to a group of persons who conduct a business together. Scots law, subject to certain limitations, has adopted the "entity" approach to partnership. In summarising the basic features of partnership law we draw attention to some of the effects of these different approaches.

Agency

2.10     In England and Wales a partner cannot be an agent of the partnership as an entity because it lacks legal personality. Whenever a partner makes a contract, it is on behalf of that partner and the other partners.^[12] If they breach the contract they will be liable for any consequential loss without limit of liability.
2.11     In Scots law the partners are agents of the partnership which is the principal.^[13] The partnership has primary liability for all debts and obligations which it incurs through the agency of its partners. The liability of the partners is subsidiary in nature.^[14] In effect the partners are guarantors of the partnership. Because they have subsidiary liability for the firm's debts and obligations, anything which they do (as the firm's agents) to bind the partnership binds the partners indirectly. Partners of a Scottish partnership are jointly and severally liable for the obligations of the firm.^[15] As in English law, their liability is unlimited.
2.12     The 1890 Act contains several statutory rules which set out the agency of a partner.^[16] In both jurisdictions, the partners are jointly and severally liable for loss and injury caused to a third party by a partner who commits a wrong while acting within the limits of his actual or apparent authority.^[17] Partners are also jointly and severally liable for the misapplication of money or property which a partner receives in the course of carrying on the partnership business or which is in the custody of the firm.^[18] The Act also provides that admissions and representations made by a partner concerning partnership affairs and in the ordinary course of business are evidence against the firm.^[19] There is also a provision, which has caused some concern in particular to the accountancy profession, which appears to impute to a partnership knowledge relating to partnership affairs acquired by a partner in the course of partnership business.^[20]
2.13     The liability of a partner (in English law as principal and in Scots law as quasi-guarantor) lasts for as long as other partners (as agents) have authority to bind that partner. The partner is not liable for obligations incurred before this agency relationship is created,^[21] and he is not liable for obligations incurred by his former partners after the agency relationship has ended.^[22]

Fiduciary duties

2.14     Partners place mutual trust and confidence in each other. They stand in a fiduciary relationship. A partner must display the utmost good faith towards his fellow partners in all partnership dealings. A partner owes his co-partners a duty to be honest in his dealings with third parties, even if the transactions are not of a partnership nature.^[23]
2.15     The 1890 Act contains statements on some aspects of the partners' fiduciary relationship. A partner must give any of his partners true accounts and full information of all things affecting the partnership.^[24] A partner must account to his partners for any profit which he obtains without their consent from any transaction concerning the partnership or from his use of partnership property.^[25] Similarly, a partner who carries on a competing business of the same nature as the partnership's business without his partners' consent must account for any profits made by him in that business.^[26]
2.16     Other fiduciary duties are left to the general law. A partner should not make a secret profit in the course of the sale to or purchase from his firm and must account for such profit.^[27] To avoid this duty to account a partner must make full disclosure of his interest to his fellow partners. A partner will be liable to account if he secures a personal benefit which should, as a consequence of his duties to his fellow partners, be obtained for the benefit of the firm.^[28] A partner's use of information received in the course of the partnership business to secure a personal benefit will give rise to a similar obligation.^[29]
2.17     In English law a partner's fiduciary duties are owed to his fellow partners. It appears that in Scots law certain duties are owed to the partnership as an entity: sections 29 and 30 refer to the obligation to account "to the firm". In both jurisdictions the duty to render true accounts and full information of all things affecting the partnership is a duty owed to co-partners rather than to the partnership.^[30]

Management and financial rights

2.18     Section 24 of the 1890 Act sets out partners' management and financial rights which apply in the absence of contrary agreement. These are default rules. Section 19 of the 1890 Act provides:

The mutual rights and duties of the partners, whether ascertained by agreement or defined by this Act, may be varied by the consent of all the partners, and such consent may be either express or inferred from a course of dealing.

2.19     The default rules set out in section 24 include, for example, that partners are entitled to share equally in the capital and profits of the firm,^[31] are entitled to take part in the management of the business^[32] and can agree ordinary matters connected with the partnership business by a majority^[33] so long as all partners are able to express a view.^[34] As we have already mentioned,^[35] unanimity is required for the introduction of a new partner.^[36]

Partnership property

2.20     It is necessary in English law, which adopts the "aggregate" approach to partnership, to distinguish between property held for the partnership and the property of its individual members. This is done in the 1890 Act by the concept of partnership property.^[37] It is of fundamental importance in distinguishing between the assets available to meet the claims of the creditors of individual partners and the creditors of the partnership and in attributing the benefit of any increase in the value of the property.
2.21     It is not always easy to determine whether an asset is partnership property. Property can be used for the purposes of the partnership and yet not be part of the partnership's property.^[38] Its status depends on the agreement, express or implied, between the partners. If there is no express agreement sections 20 and 21 of the 1890 Act set out the factors which will generally be relevant.^[39] The circumstances behind and the purpose of the acquisition of the asset, the source from which it is financed and how it is subsequently dealt with, will normally determine the status of the property.
2.22     In English law a legal estate in land can only be held by a maximum of four partners.^[40] For larger firms four partners will hold the legal estate on trust for themselves and their co-partners according to their beneficial interests. Other options are for a partnership to vest land in a company controlled by the partnership or in a nominee which holds the land in bare trust for the firm. This avoids the need to transfer the estate on the death or retirement of one of the trustees.
2.23     In Scots law, a partnership can hold moveable property such as vehicles, computers and intellectual property. It can also hold title to a lease of heritable property. But it is common practice to take title to leases in the name of trustees for the firm. The prohibition against the partnership holding title to feudal property has resulted in the partners taking title to heritable property as trustees for the firm.^[41] The options of vesting land in a company or in a nominee are available as in England and Wales.
2.24     The trust by which a partner or partners hold property in trust for the firm is often implied rather than express and similar issues arise as to the status of the property as in England and Wales. The agreement of the partners, express or implied, determines the status of the property.^[42] Again sections 20 and 21 of the 1890 Act illustrate factors which are relevant to establishing such agreement.
2.25     The separate personality of the Scottish partnership prevents partners having title to sue for damage to partnership property or having an insurable interest in partnership property.^[43]

Duration of partnership

2.26     A partnership falls into one of two categories namely a partnership at will or a partnership for a fixed term. The default rule is the partnership at will: it exists where the partnership agreement is silent as to the duration of the partnership.^[44] A partner in a partnership at will can dissolve the partnership immediately by notice.^[45] In absence of agreement between the partners to the contrary, the partnership must then be wound up. Transactions begun but unfinished may be completed,^[46] and the partnership's assets distributed.^[47]
2.27     Unless the partners agree otherwise, the death or bankruptcy of a partner means that the partnership is dissolved as regards all partners and that it should be wound up.^[48] This is so even if the partnership was entered into for a fixed term which has not expired.^[49]
2.28     In a partnership for a fixed term, a partner who wants to retire can only do so with the consent of his fellow partners. Alternatively, he can apply to the court to wind up the firm under section 35 of the 1890 Act.
2.29     If a partnership for a fixed term is continued after the expiry of that term, without any express new agreement, the rights and duties of the partners remain the same as they were at the expiration of the term, so far as is consistent with the incidents of a partnership at will.^[50] In English law, where a new partner is admitted to a fixed term partnership, that partnership is determined and a new one is created, which may also be a fixed term partnership or a partnership at will, depending upon the terms of the original agreement.^[51]
2.30     All the partners can agree to dissolve the partnership. The partnership agreement may provide that unanimity is not required so that a majority of partners can decide to dissolve the firm.
2.31     A temporary cessation of business may not cause a dissolution.^[52] But, as the very existence of a partnership is intrinsically linked to the carrying on of a business, an agreement of the partners permanently to cease all forms of business must be taken as an agreement to dissolve the partnership.
2.32     A partnership is dissolved where an event occurs which makes it unlawful to carry on the business of the firm or for the members to carry it on in partnership.^[53] The 1890 Act also provides that a partner may apply to the court to dissolve a partnership on a number of specified grounds, including the general ground that it is just and equitable that the partnership be dissolved.^[54]
2.33     Views differ as to whether a partnership is dissolved where a repudiation of the partnership contract is accepted by the partner or partners not in breach.^[55] There are also differing views on whether the frustration of the partnership contract brings a partnership to an end.^[56]

The effect of changes in membership of the firm on third parties

2.34     In both jurisdictions, the basic contractual position is that a party to a contract cannot transfer his obligations under that contract without the other party's consent.^[57]
2.35     In English law a contract with a partnership is a contract with the members of that firm. It is a matter of construction whether a contract can be performed "vicariously" by another set of persons, for example, a "new" partnership. In general it is more likely that dissolution of the firm on a change in its membership terminates a contract when the firm is small, than where the contract is with a larger firm.^[58]
2.36     In Scots law, similar issues arise, notwithstanding the separate personality of the firm. It is a matter of construction of the contract with the partnership as to whether the contract is with the firm as it is then constituted, or is with the firm (viewed as a continuing entity) as it might be constituted from time to time. The concept of a contract "with the house" which allows third parties to contract with the firm and its successors which carry on the same business is an established device in Scots law^[59] but its conceptual basis is unclear.
2.37     In contracts of suretyship in English law and cautionary obligations in Scots law a change in the person for or to whom a third party stands as surety or cautioner may alter the third party's risk and so relieve him of liability, unless he consents to the change. This rule is preserved in section 18 of the 1890 Act.
2.38     Changes in the membership of a partnership can also cause difficulty in relation to other contracts. For example, insurance contracts are personal contracts and cannot normally be assigned without consent. This restricts the ability of a firm effectively to assign such contracts to the new firm, resulting from a change of membership.^[60]
2.39     If a partnership maintains a single running account with a bank, on a change of membership of the firm, the well-known rule in Clayton's Case^[61] will apply. Withdrawals from the account will operate to reduce or cancel deposits in the order in which they were made - the "first in, first out" rule. Deposits will be applied in reduction of indebtedness in the same order. For partnerships this means that money paid into a current account by the "new" firm will reduce the debts of the "old". Therefore, if deposits of the "new" firm exceed the debts of the "old", a debit balance on the account will be the liability of the "new" firm alone. If the "new" firm becomes insolvent, the creditor has no recourse against the "old" firm whose indebtedness has been discharged. To avoid this, banks will often "freeze" the current account when a partner leaves the firm and thus keep the accounts of the "old" and "new" firms separate.

Partners' liability and a third party's access to information

2.40     A partner's liability for new debts incurred on the firm's behalf lasts for as long as other partners (as agents) have authority to bind that partner.^[62] Nonetheless, third parties are entitled to assume that the other partners remain agents until they are notified to the contrary.^[63] Partners should therefore notify any future clients by advertising their withdrawal from the partnership in the Gazette.^[64] An outgoing partner who wishes to avoid any liability for post-withdrawal partnership debts may require to notify clients who had dealings with the firm before his withdrawal as the Gazette advertisement is notice only to persons who had no such dealings.
2.41     It is often difficult for a third party to ascertain who was a partner at a particular time. The Business Names Act 1985 requires the disclosure of the names of current partners where the firm has a place of business and carries on business in Great Britain under a business name which does not consist exclusively of the surnames of all of the partners (with certain permitted additions). The problem for the third party is that the Act does not require a firm to maintain a record of when a person became a partner or of former partners who have since withdrawn from the firm. The Act does not help the third party establish at a later date who were the partners at the time a liability was incurred. The third party may get access to that information when he initiates litigation against the firm. Rules of Court in England and Wales allow a claimant to require the disclosure of the names and addresses of the relevant partners.^[65] In Scotland, the court may grant an order requiring the production of documents disclosing such information.^[66]

Insolvency

2.42     English law and Scots law have radically different insolvency regimes for partnerships. In English law there has been an attempt to assimilate partnerships into the framework that governs corporate insolvency.^[67] This is currently under review and is not within the scope of this report. By contrast partnership insolvency in Scots law is regulated by the Bankruptcy (Scotland) Act 1985, which provides the regime for individual insolvency.^[68]

Note 1    (1877) 5 Ch D 458, 472.    [Back]

Note 2    [2002] 1 AC 185.    [Back]

Note 3    [2003] Ch 250.    [Back]

Note 4    Sadler v Whiteman [1910] 1 KB 868, 889, per Farwell LJ.    [Back]

Note 5    There has been an academic debate in the United States of America on the conceptual approach to partnership: see Gary S. Roslin, “The Entity-Aggregate Dispute: Conceptualism and Functionalism in Partnership Law” (1989) 42 Arkansas Law Review 395 – 466. The move in the United States from the aggregate theory of partnership to the entity theory in section 201(a) of the Revised Uniform Partnership Act (RUPA) has enjoyed broad support while other aspects of RUPA have been controversial. See Alan W. Vestal ““…Drawing Near the Fastness?” – the failed United States experiment in unincorporated business entity reform”, (2001) The Journal of Corporation Law Vol 26, No 4, 1019 – 1030. See Part V below.    [Back]

Note 6    Lord Lindley quoted in Lindley & Banks on Partnership (18th ed 2002) para 3-04; and see Green v Herzog [1954] 1 WLR 1309.    [Back]

Note 7    Hadlee v Commissioners of Inland Revenue [1989] 2 NZLR 447, 455 per Eichelbaum CJ.    [Back]

Note 8    1890 Act, s 4(2).    [Back]

Note 9    Historically, a Scottish partnership has not been entitled to hold title to immoveable property held on feudal tenure but this restriction will disappear when s 70 of the Abolition of Feudal Tenure etc (Scotland) Act 2000 is brought into force.     [Back]

Note 10    There are however anomalous rules as to how a partnership may sue and be sued, depending upon whether the partnership has a “social” name or a “descriptive” name. See para 7.7 below.     [Back]

Note 11    See Part V below.    [Back]

Note 12    1890 Act, s 5.    [Back]

Note 13    1890 Act, s 5.    [Back]

Note 14    See Mair v Wood 1948 SC 83, 86 per the Lord President (Cooper).    [Back]

Note 15    1890 Act, s 9.    [Back]

Note 16    Sections 5 and 6 set out the express, implied and apparent authority of the partner. Specific rules restricting the liability of the firm where a partner uses the credit of the partnership for private purposes and where notice has been given of a restriction on a partner’s authority are contained in ss 7 and 8.    [Back]

Note 17    1890 Act, ss 10 and 12.    [Back]

Note 18    1890 Act, ss 11 and 12.    [Back]

Note 19    1890 Act, s 15.    [Back]

Note 20    1890 Act, s 16. The operation of this rule is considerably more complex than the terse statutory wording suggests and is discussed in paras 6.15 – 6.21 below.    [Back]

Note 21    1890 Act, s 17(1) (in absence of agreement to the contrary).    [Back]

Note 22    See paras 6.81 – 6.83 below and the 1890 Act, s 36.    [Back]

Note 23    See Carmichael v Evans [1904] 1 Ch 486. In this context “honest” means abstaining from fraud.     [Back]

Note 24    1890 Act, s 28.    [Back]

Note 25    1890 Act, s 29.    [Back]

Note 26    1890 Act, s 30.    [Back]

Note 27    Gordon v Holland (1913) 108 LT 385.    [Back]

Note 28    Powell and Thomas v Evan Jones & Co [1905] 1 KB 11.    [Back]

Note 29    Boardman v Phipps [1967] 2 AC 46.    [Back]

Note 30    1890 Act, s 28.    [Back]

Note 31    1890 Act, s 24(1).    [Back]

Note 32    1890 Act, s 24(5).    [Back]

Note 33    1890 Act, s 24(8).    [Back]

Note 34    Const v Harris (1824) Turn & R 496, 525; 37 ER 1191, 1202; Lindley & Banks para 15-08;Miller, p 185.    [Back]

Note 35    See para 2.3 above.    [Back]

Note 36    1890 Act, s 24(7).    [Back]

Note 37    1890 Act, s 20(1).    [Back]

Note 38    See, for example, Miles v Clarke [1953] 1 All ER 779.    [Back]

Note 39    The partnership accounts are often a good guide as to whether an asset is partnership property. If every partner has agreed to the inclusion of an asset in the balance sheet, this will normally be sufficient agreement.    [Back]

Note 40    Trustee Act 1925, s 34(2); Law of Property Act 1925, s 34(2).    [Back]

Note 41    See para 2.7 and footnote 9 above.    [Back]

Note 42    Bell, Comm, II, 501-502. The title of a bona fide third party may however prevail over a latent trust: see Redfearn v Somervail (1813) 1 Dow 50; 3 ER 618.    [Back]

Note 43    SeeMacLennan v Scottish Gas Board, First Division 16 December 1983 (unreported on this point); Arif v Excess Insurance Group Ltd 1987 SLT 473; Mitchell v Scottish Eagle Insurance Ltd 1997 SLT 793.     [Back]

Note 44    Moss v Elphick [1910] 1 KB 465 and 846; Walters v Bingham [1988] 1 FTLR 260; Abbott v Abbott [1936] 3 All ER 823.    [Back]

Note 45    1890 Act, ss 26 and 32.    [Back]

Note 46    1890 Act, s 38.    [Back]

Note 47    1890 Act, ss 39 and 44.    [Back]

Note 48    1890 Act, s 33.    [Back]

Note 49    Gillespie v Hamilton (1818) 3 Madd 251; 56 ER 501; Downs v Collins (1848) 6 Hare 418; 67 ER 1228; Lancaster v Allsup (1887) 57 LT (NS) 53.    [Back]

Note 50    1890 Act, s 27(1).    [Back]

Note 51    Firth v Amslake (1964) 108 SJ 198. The position in Scots law is unclear: see para 2.8 above.    [Back]

Note 52    Millar v Strathclyde Regional Council 1988 SLT (Lands Tribunal) 9.    [Back]

Note 53    1890 Act, s 34.    [Back]

Note 54    1890 Act, s 35.    [Back]

Note 55    See paras 8.83 – 8.84 below.    [Back]

Note 56    See para 8.83 below.    [Back]

Note 57    Humble v Hunter (1848) 12 QB 310, 317; 116 ER 885, 887; Don King Productions Inc v Warren and Others [2000] Ch 291, 318-319; Gloag, Contract (2nd ed 1929) p 416 but cf Cole v Handasyde & Co 1910 SC 68.    [Back]

Note 58    Briggs v Oates [1990] ICR 473, 482. See also Sheppard & Cooper Ltd v TSB Bank plc [1997] 2 BCLC 222.    [Back]

Note 59    See, eg, Alexander v Lowson’s Trustees (1890) 17 R 571.    [Back]

Note 60    For other complications caused by a change in the partners see Lindley & Banks paras 3-08 – 3-16.    [Back]

Note 61    (1816) 1 Mer 572; 35 ER 781.    [Back]

Note 62    In English law the partner is bound as principal; in Scots law he is bound through his subsidiary liability for the firm’s debts.    [Back]

Note 63    1890 Act, s 36.    [Back]

Note 64    1890 Act, s 36(2). If the firm is English or Welsh the notice is in the London Gazette; if the firm is Scottish it is in the Edinburgh Gazette.     [Back]

Note 65    CPR, Sched 1, RSC O 81, r 2.    [Back]

Note 66    Mitchell v Grangemouth Coal Co (1894) 2 SLT 104.    [Back]

Note 67    See the Insolvency Act 1986 as applied by the Insolvent Partnerships Order 1994 (SI 1994/2421). See also Davis, Steiner and Cohen, Insolvent Partnerships (1996) and P Totty and G Moss, Insolvency (1986).    [Back]

Note 68    See McBryde, Bankruptcy (2nd ed 1995).    [Back]