Scottish Law Commission (Reports)

PART III
OVERVIEW OF PROPOSED REFORMS

The principal aims of partnership law reform

3.1     The rules of partnership law fall into two parts: external rules, which govern relations between the partnership and those dealing with it (customers, etc); and internal rules which govern relations between the partners themselves.
3.2     In making recommendations for reform of the general law of partnership we have four principal aims. Those aims are:

(1) to preserve partnership as a flexible, informal and private business vehicle;

(2) to encourage continuity of business by facilitating continuity of partnership;

(3) to preserve mutual trust and good faith as critical components of the relationship between partners;

(4) to provide a modern law of partnership based on consistent and straightforward concepts, which are readily understandable by advisers and clients alike.

Flexibility and informality

3.3     The partnership as a form is of great antiquity:

Historically, it has a traceable course from the ancient civilisations of Mesopotamia to classical Greece and Rome and hence onwards through medieval commercial practices and the far-flung enterprises of the Renaissance to its present-day position as one of the three most important forms of enterprise in the business world.^[1]

3.4     This long history is no more than a reflection of the fact that it is the simplest form of business association. When two or more people come together in a business enterprise they need some basic rules to govern their relationship. Those rules should be as simple as possible. They should provide a basic framework governing the relations of the partners internally and with outside parties, which reflects commercial perceptions; they should provide the minimum intrusion while things are going well; and they should provide straightforward means of sorting things out when things are going badly.
3.5     Because of the great difference in size and nature of partnerships, it is vital that partnerships should retain the maximum flexibility in the way in which they organise themselves. Larger and more sophisticated partnerships have formal partnership agreements, but many small partnerships do not. Small partnerships play an important role in the economy. The 1890 Act contained a number of default provisions, that is, provisions which would apply unless the partners agreed otherwise. We have extended this approach in the proposed legislation by providing default clauses which together form a code of government for partnerships that will apply unless the partners choose to vary it (as they are free to do).
3.6     In drafting the default code we have followed a policy of "think small first". Large partnerships are likely to have their own tailor made agreements. Small partnerships are not. The default code is intended to make life simpler for them by providing a suitable ready made set of rules, which they can change if they wish, and to reduce the likelihood of litigation (with its uncertainty, delay and cost) in the event of the partners falling out, because there will be an applicable set of rules in place.

Continuity and independent personality

Encouraging continuity

3.7     The responses to consultation have convinced us that it is a serious defect of the 1890 Act that it provides no simple means to extend the life of a partnership, on a change of partners, and no presumption in favour of continuity. In English law, whenever the membership changes the partnership is in theory dissolved, and a new partnership created.^[2] Furthermore, again apart from any provision in the agreement, a single partner can bring about a general dissolution simply by serving notice terminating the partnership.
3.8     It has often been observed that, in this respect, the legal position is far removed from the ordinary perceptions of those involved. In the words of one commentator:

… the great disadvantage of a partnership at will^[3] is that … it may be dissolved by any one partner at any time by simply giving notice to that effect to his co-partners. On such a dissolution, a partner in the firm is then entitled to have the firm wound up. It follows that the consequences of having a partnership at will are potentially devastating. Nonetheless, a concerning aspect of the 1890 Act is that the default form of partnership created thereunder is a partnership at will. This means that those successful trading or professional firms which are informally created are subject to winding up at the whim of one partner. Indeed, it is apprehended that there are many successful firms which are partnerships at will but in which the partners would be astonished to discover that they are subject to this risk … In this way, it is suggested that the law of partnership fails the reasonable expectations of business men… .^[4]

3.9     We highlighted this problem in the Joint Consultation Paper and proposed to address it in our reforms. Our proposal was to introduce a default rule that in such situations, provided that two or more partners remained, the partnership was not dissolved.^[5] Instead, the deceased or outgoing partner could be bought out, leaving the partnership to continue between the remaining partners. There was widespread support in principle for this proposal among consultees. It was perceived as benefiting not only the members of a partnership but also those who deal with partnerships and as better reflecting the perceptions of business people.

Notice period and financial rights

3.10     We have developed these proposals in more detail since the Joint Consultation Paper.^[6] In particular, we propose an arrangement by which the outgoing partner must give a period of notice of withdrawal in order to allow the other partners an opportunity to consider their position and to respond to that withdrawal.^[7] While this was not part of our original proposals in the Joint Consultation Paper, we are persuaded that it is a desirable reform in order to achieve a workable and fair regime for changes of partners where there is continuity of partnership.
3.11     Continuity of partnership will mean that an outgoing partner will normally have an entitlement to payment of his share in the partnership instead of a right to have the partnership wound up. We have decided against detailed statutory valuation rules, both because valuation practice may alter in future and because the rules might be unsuitable for many partnerships. We recommend that there should be a basic default principle that the outgoing partner is entitled to be paid the value of his share in the partnership on a notional sale of the partnership business. This reflects closely the existing financial rights of a partner as to the application of partnership property on the dissolution and winding up of a partnership.^[8]

Independent legal personality

3.12     As already explained,^[9] under English law partners are agents of each other, but the partnership does not exist as a legal entity. As mutual agents, the partners share unlimited liability for all obligations incurred to other people in the course of the partnership. They also owe each other a duty of good faith (but, provided that they act honestly, they are otherwise free to regulate their affairs between themselves as they wish).
3.13     Under Scots law a partnership is a legal entity, but the partners have the same unlimited liability towards those who deal with it, and have the same duty of good faith towards each other, as they would under English law.
3.14     We think that it would be much more satisfactory in today's world that a partnership should be a legal entity. In 1890 all partnerships were small concerns. Twenty was the maximum number of partners permitted by the law. That restriction has been removed, and partnerships now vary in size from two to many hundreds. But the framework of partnership law was simply not devised for larger partnerships.
3.15     Many people would be astonished to learn that a firm is automatically dissolved whenever there is a change of partner, or that it cannot own property, but that remains the law in England and Wales (although not in Scotland). In practice, firms habitually operate as if they were legal entities and are regarded as entities by those who deal with them. The fact that they are not presently recognised as such by the law is a throw back to the nineteenth century.
3.16     We believe that it is time to end this anomaly and that partnerships in England and Wales should become legal entities, so that their legal nature would reflect their role in the commercial life of Britain today. Partnerships would be able to enter contracts and hold property; they would not be automatically dissolved on any change of partner; but partners would continue (as in Scotland) to be personally responsible for the obligations of the partnership and would continue to owe duties of good faith to each other. The result would be a largely uniform law of partnership in England, Wales and Scotland.
3.17     Legislation will be needed to ensure that this change does not result in any change in the treatment of partnerships under UK tax law. We have received confirmation from the Inland Revenue of its intention that (subject to ministerial approval) the necessary legislation will be included in a Finance Bill.^[10]

Mutual trust and good faith

3.18     Partners have to trust each other in order to engage in a business for their joint benefit. Before the 1890 Act, the courts recognised the central importance of the fiduciary relationship in partnership:

If fiduciary relation means anything I cannot conceive a stronger case of fiduciary relation than that which exists between partners. Their mutual confidence is the life blood of the concern. It is because they trust one another that they are partners in the first instance; it is because they continue to trust each other that the business goes on.^[11]

3.19     Notwithstanding that recognition, the 1890 Act does not contain a general statement of the duty of partners to act in good faith. Rather, the Act contains certain rules which are examples of obligations arising out of the particular fiduciary relationship which partnership involves.^[12]
3.20     As mutual trust underpins partnership, we believe that there should be a statutory statement that in relation to any matter affecting the partnership a partner must act in good faith towards the partnership and each of the other partners. As this duty is fundamental to partnership, it should not be capable of being excluded by the partnership agreement. By their agreement partners may determine the nature and extent of the particular duties which they undertake to each other and to the partnership. But we think that it would be inconsistent with the partnership relationship if partners were to exclude their duty of good faith.^[13]

Clarity of concept

The 1890 Act as a "model"

3.21     The 1890 Act has often been praised as a model of its kind,^[14] but not all comment has been so kind. The leading Australian textbook comments critically on the results of the long period of gestation of the Bill, following Sir Frederick Pollock's draft of 1879:

In the course of the succeeding decade the Bill was resubmitted at frequent intervals, suffering alterations and deletions, almost amounting to mutilation, and resulting in many obscurities in the Act. In these circumstances, although the Act that ultimately reached the statute book in 1890 was based upon Pollock's original Bill, he is not wholly to blame for its many ambiguities and inaccuracies.^[15]

Missing links

3.22     Our own work on the project has confirmed our respect for the 1890 Act as a whole, in particular its simplicity of expression. However, we have also been struck by the lack of clarity on some important concepts and by the ambiguity concerning the continuance of a partnership on a change among the partners. In relation to the latter, while it remains a basic rule of the English law of partnership that a change in membership creates a new partnership,^[16] some sections of the 1890 Act appear to assume continuity of partnership.^[17] Other sections, by contrast, do not.^[18] In relation to the former, we take two examples: the nature of partnership property and the role of contractual remedies.

Partnership property

3.23     It is a surprising feature of the 1890 Act that the same provision (section 20(1)) defines "partnership property" in both England and Scotland, even though the nature of the interest is, in theory at least, quite different in the two jurisdictions. In Scotland partnership property is owned by, or held in trust for, the partnership as a separate person;^[19] in England, it is owned by the partners who have "a beneficial interest, in the form of an undivided share, in the partnership assets".^[20]
3.24     There is no guidance in the 1890 Act, and very little discussion in the textbooks, of how English law achieves the transfer of property on a change of membership in a continuing partnership. Where a partnership is initially the aggregate of A, B and C but A resigns and D is admitted as a partner, a new partnership comes into being as the aggregate of B, C and D. The problem is how the property of the "old" partnership comes to be transferred to the "new" partnership.^[21]
3.25     One important practical issue is whether "partnership property" is available to satisfy a judgment against the partnership, where the membership has changed since the cause of action arose. The 1890 Act makes clear that an incoming partner is not personally liable for anything done before he became a partner,^[22] but says nothing about execution against partnership property to which he has contributed. English rules of court enable the partners to be sued in the name of the partnership,^[23] but this is said to be no more than a procedural convenience for naming the partners at the time the cause of action arose.^[24]
3.26     This view appears to conform to that of the Insolvency Service, who commented in response to the consultation:

We also note that one of the effects of continuing legal personality is that new partners' capital contributions would be available to meet the existing liabilities of the partnership. Since this mirrors what we suspect most partners and creditors believe happens when the composition of a firm changes, we think it is to be welcomed.

3.27     However, that is not a universal view. In their response, the Chancery Bar Association commented that our proposals would involve "a major change in the law" because "the capital of an incoming partner (would be) available for the use of the creditors of the old firm". It seems strange that this potentially important issue remains unresolved.^[25] Under our proposals, the incoming partners would not be personally liable for "old" debts, but the liability would be that of the continuing partnership, and its property (whatever the source) would be available for execution.

Contractual remedies

3.28     The recent case of Hurst v Bryk^[26] has revealed considerable uncertainty in partnership law as to the respective roles of contractual and equitable doctrines. In that case, it was common ground up to the Court of Appeal that the contractual doctrine of repudiation of contract applied to partnerships with the effect that an acceptance by the innocent parties of a repudiation of a partnership agreement dissolved the partnership. In the House of Lords, Lord Millett challenged that view. Although a contract was necessary to bring a partnership into being, once created it was subject to the control of the courts of equity, and dissolution, unless consensual, was equally subject to control.^[27] This view was not part of the decision and has received criticism, but it has been followed in a decision at first instance.^[28] It is remarkable that, even among experts, an issue so fundamental to the conceptual nature of partnership in English law has been uncertain.
3.29     The present draft Bill provides an opportunity to clarify the position. It views the partnership as a legal person, whose characteristics are determined (a) by the draft Partnerships Bill except so far as varied by contract and (b) by the terms of the partnership contract (if different from the default rules in the draft Bill) and (c) by the rules of common law and equity so far as not inconsistent with the terms of the draft Bill. On this approach the draft Bill will provide the framework in which a partnership comes into existence and is terminated. The grounds of termination will be those, if any, which the partners agree upon in their partnership agreement and those set out in the draft Bill.^[29] The partnership will not be terminated by the operation of contractual doctrines such as frustration and repudiation of contract but by agreement or by order of court or by the number of partners falling below two.

An accessible code

3.30     Partnership law has to be accessible to a wide range of users and their advisers. Clarity of concept is as important as clarity of language. The market should not be seen as purely domestic. In recent years, there has been increasing competition between jurisdictions to produce business organisations which will be attractive to businessmen who operate internationally. This is evident in the reforms which have been introduced in many jurisdictions to legislation on limited partnerships and in the emergence of the limited liability partnership. Within the European Union, the decision of the Court of Justice in Centros Ltd v Erhvervs-og Selskabsstyrelsen^[30] encourages jurisdictional competition. Ribstein states:

The recent Centros decision raises important questions about the future of European law, particularly the law of business organisations. By characterising a corporation as eligible for the privileges and immunities of a full-fledged citizen of its state of origin, including the right to establish a branch in a country outside its origin that is subject to home-state law, Centros sets the stage for increased jurisdictional competition for European business law.^[31]

3.31     The law of partnership should be based on straightforward and consistent concepts, which can be readily understood by, or explained to, all categories of potential users and their advisers, domestic or foreign.^[32]

Concepts in the draft Bill

Partnerships as a legal entity

3.32     As discussed above, we recommend that partnerships in England and Wales should as a general rule be legal entities. For reasons explained below, we recommend a limited exception to the general rule in the case of certain limited partnerships.

The liability of partners

3.33     It is a fundamental concept that the partners in a general partnership have unlimited liability for the obligations incurred by the partnership while they are partners. We discuss the liability of partners in Part VI.^[33] By contrast a limited partnership must have one or more general partners each of whom has unlimited liability and one or more limited partners each of whom has limited liability. We discuss the liability of the general partner and the limited partner in Parts XVI and XVII. As the draft Bill covers both general partnerships and limited partnerships,^[34] we think that it is appropriate to have a statement of the liability of partners early in the draft Bill (cl 3).

The partnership agreement

3.34     A partnership can only come into existence by an agreement between the partners. Such an agreement may be written, oral or inferred from conduct in whole or in part. The partnership agreement also provides the constitution which governs the partnership and the relationship between the partners. The agreement may contain a mechanism for the amendment of certain of its terms, for example by a special majority vote. In the absence of such a provision it requires the agreement of all the proposed partners or, after the partnership has been formed, all the partners to vary the partnership agreement. The draft Bill contains a provision to this effect (cl 4).

Default partnership rules

3.35     The flexibility of partnership law depends on allowing partners to determine the terms of their agreement. The 1890 Act by creating default rules which govern the relationship between the partners, subject to any contrary agreement, preserves this flexibility. Section 19 of the 1890 Act provides:

The mutual rights and duties of partners, whether ascertained by agreement or defined in 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.

3.36     We aim to preserve this flexibility and also to make clear which of the rules in the draft Bill are default rules and which are not. This we do by stating in each clause whether or not it is a default rule. We consider that it would be useful also to define a default rule as a rule which applies in relation to a partnership if the point dealt with in the rule is not dealt with in the partnership agreement. As default rules confer rights and duties on partners which the partners may wish to enforce against each other, we think that there should be a statement of the status of the default rules as terms of the partnership agreement. In function they are statutorily implied terms of a partnership agreement and we consider that a default rule should be treated as if it were a term of the partnership agreement so that partners may enforce their rights against each other in contract.^[35] Finally, we think that it should be provided that partners may modify or exclude a default rule in accordance with the terms of the partnership agreement or if all the partners agree (draft Bill, cl 5).^[36]

Other reforms

Solvent dissolution

3.37     Simplification of solvent dissolution was one of the issues expressly mentioned in our terms of reference. We recommend that a new system be introduced for the winding up of solvent partnerships when the partnership business is discontinued. Our recommendations will not prevent partners from agreeing the appropriate methods of winding up a partnership business. But problems occur where there is dissent among the partners and it becomes necessary to introduce a third party to effect the winding up. In England and Wales winding up under the supervision of the court is time-consuming and expensive. In Scotland also, winding up through the appointment of a judicial factor by the court causes expense, delay and difficulty. What is required is an officer with sufficient independent powers to wind up the partnership business and determine the financial rights and liabilities of the partners in an efficient manner.
3.38     We recommend that the court should have power to appoint a partnership liquidator with powers and duties modelled on those of a liquidator in a members' voluntary winding up of a company.^[37] The partnership liquidator would be given express power, without the sanction of the court or the approval of the partners, to take specified steps for the winding up of the partnership's affairs and distributing its assets. He would require the sanction of the court or the unanimous approval of the partners to carry on the business for its beneficial winding up or to take other specified actions.^[38]

Miscellaneous issues

3.39     The introduction of continuity of partnership and separate legal personality will require the reformulation of a number of the provisions of the 1890 Act including the provisions relating to partnership property. We also recommend reform of the rules of litigation and the enforcement of claims against a partnership and its partners.

Transitional provisions

3.40     We recommend that the new partnership rules should apply to all partnerships created after the commencement of the new Partnerships Act and to all other partnerships from a date two years after the commencement of the Act. In the interim partnerships created before the new Act comes into force may elect to be governed by the new Partnerships Act. We have recommended the delay in applying the new partnership rules to all partnerships in order to give existing partnerships time to consider the provisions of the new Act and, if the partners think it appropriate, to contract out of the default regime of the new Act.
3.41     We received forceful representations from the Association of Partnership Practitioners (APP) that it was necessary to go further to protect the expectations of partners who had deliberately chosen to adopt the default regime of the 1890 Act which entitles an outgoing partner to insist on the winding up of the partnership on his departure.^[39] In order to protect such expectations we recommend that an individual partner should have the right during the interim period to elect that the default regime of the 1890 Act should continue to apply to the partnership of which he is a member. This will enable Parliament to introduce the reforms to the default code without fear of taking away vested contractual rights from persons who wished to retain them.

Proposals which we are not taking forward

3.42     In the Joint Consultation Paper we discussed a proposal to introduce a new form of partnership with separate legal personality, the registered partnership. While there was some support for the proposal, particularly from financial bodies which lend money to partnerships, there was also strong opposition on the grounds that it involved unnecessary bureaucracy and complexity, that it would be expensive to administer and that there was little incentive for partnerships to register. While we recognise the advantages of transparency which a registration system may offer, nevertheless we are persuaded that it would not be appropriate to introduce the registered partnership.^[40]
3.43     We are not proposing, as part of this project, that partnerships should have power to grant floating charges. In the absence of a registered partnership, or a general reform of the law of registration of charges, we do not think that it is practicable for partnerships to be allowed to grant floating charges. The Law Commission is consulting on a general reform of the law relating to charges over property other than land.^[41] Although that project is directed in the first instance to company charges, it is also making proposals for non-corporate debtors, including partnerships.^[42] This will provide an opportunity to review the issue of floating charges, in that context.

Limited partnerships

3.44     The Limited Partnerships Act 1907 has been criticised for its failure to create a coherent body of law and for the resulting uncertainty regarding the rights and obligations of general and limited partners.^[43] In our Joint Consultation Paper on Limited Partnerships we sought to identify the main areas in which the law required clarification. We recognised that business people use limited partnerships for specialised purposes and that most limited partnerships would have written partnership agreements governing the rights and obligations of the partners. As a result, there is less need in this specialised field to have a default regime. Rather the need is twofold: first, the application of the rules of the general law of partnerships to limited partnerships has to be clarified and, secondly, the role which a limited partner may play in a limited partnership without risking the loss of limitation of liability should be more closely defined.
3.45     Among the detailed recommendations for clarifying the law and for weaving limited partnerships into the general law of partnership we recommend that limited partnerships should be required to disclose their limited liability status, that the general partner alone should be responsible for default in registration formalities, that registration of a limited partnership should be conclusive as to its existence, that the liability of the limited partner should be limited to the amount of capital actually registered,^[44] that legislation should provide guidance on the activities which a limited partner may undertake without losing limited liability status, and that the Registrar of Companies should be empowered to de-register defunct limited partnerships.

Special limited partnerships

3.46     Limited partnerships have become a popular vehicle among venture capitalists for both UK and non-UK investment funds. We have referred to the increasing competition between jurisdictions to produce business organisations suited to international markets.^[45] Serious concerns have been expressed to us, particularly by the APP, that giving legal personality to limited partnerships may affect their tax treatment overseas, and that uncertainty over that issue would affect their usefulness as a vehicle for investment and, therefore, be damaging to the economy. For those special reasons we propose that those who wish to do so should be able to enter into special limited partnerships which would not have separate legal personality.^[46]

Form and style of the draft Partnerships Bill

3.47     The draft Bill seeks to combine in one code introductory provisions which apply generally to partnerships and provisions which apply particularly to general partnerships and to limited partnerships respectively. By this means we seek both to preserve the flexibility of the statutory partnership code and to integrate the rules relating to limited partnerships into that code.
3.48     The draft Bill is similar to Sir Frederick Pollock's 1879 draft Bill in that it deals with both general partnerships and limited partnerships. The 1879 Bill comprised 97 clauses and two short schedules. Our draft Bill is longer than the combined 1890 and 1907 Acts principally because of additional clauses and schedules relating to limited partnerships and the new provisions relating to the partnership liquidator.

Matters not dealt with

3.49     Finally, in this Part we refer to two matters of domestic law which will be of importance to the reform of partnership law, but are not dealt with in detail in the present Bill.

Tax law

3.50     Notwithstanding the differences in the nature of partnership between the two jurisdictions, their treatment for tax purposes should in principle be the same.^[47] In particular, the separate personality of partnerships in Scotland has not affected their transparency for tax purposes.
3.51     In fact, tax law has a variety of special rules, varying as to the extent to which the partnership is treated as separate from the partners, for example:-

(1) Value Added Tax (VAT): Registration of a partnership may be in the name of the firm, and "no account shall be taken in determining …. whether goods or service are supplied to or by such persons … of any change in the partnership".^[48]

(2) Income Tax: There has been a radical change during the 1990s from joint to separate liability, accompanying the change from the "preceding year" to the "current year" basis:

(a) Former system: Under the former "preceding year" basis, profits taxed in any year were those of the firm^[49] in the accounting period ending in the previous tax year, which was then treated as divided between the then partners for the purpose of calculating allowances, leading to a global assessment on the firm.^[50] The tax was thus a debt of the partnership, for which all the partners were jointly liable.

(b) Current system: Under the new current year basis, it is provided that where a trade is carried on by persons in partnership, the partnership "shall not, unless the contrary intention appears, be treated for the purposes of the Tax Acts as an entity which is separate and distinct from those persons."^[51] The profits or losses from the business are computed as if the partnership were an individual, and an individual partner's share is determined in accordance with the partner's shares in the partnership during the period.^[52] Each partner is personally liable for tax only on his own share.

(3) Capital Gains Tax: The firm as such is disregarded, and all dealings in partnership assets are treated as dealings by individual partners.^[53] The working out of this concept in practice has not been easy, and has had to be regulated by extra-statutory guidance.^[54]

3.52     We regard it as important that our proposed reforms should not materially alter the treatment of partnerships for tax purposes, although they may provide an opportunity for addressing some of the anomalies of the present law. We have had the benefit of discussions with the Inland Revenue, who have seen a draft of this report and have considered our recommendations. If Parliament implements our recommendations by enacting a new Partnerships Bill, it will be necessary to alter taxation legislation to take account of the changes which the new Act will effect.^[55]
3.53     The Inland Revenue propose to bring forward the necessary provisions in time to coincide with the enactment of any new Partnerships Bill. As the taxation consequences of any reform of partnership law are of great importance to business people who use partnerships, the Inland Revenue have authorised us to publish the following statement of their intentions:

The Inland Revenue has confirmed that, following any decisions by Parliament on partnership law, Treasury Ministers currently intend to bring forward any tax legislation necessary to maintain the present policy of generally treating partnerships as transparent for tax purposes.

Insolvency

3.54     Our terms of reference do not include consideration of the law of partnership insolvency. It would in any event have been an unsuitable subject for a joint project between the two Commissions, in view of the different approaches of the two jurisdictions. In England and Wales, the Insolvency Act 1986, as applied in modified form by the Insolvent Partnerships Order 1994,^[56] assimilates partnerships into the framework governing corporate insolvency. In Scotland, by contrast, insolvency is regulated under the Bankruptcy (Scotland) Act 1985, which provides the regime for individual bankruptcy.^[57]
3.55     However, there is a general recognition of the need for simplification and modernisation of English law, as contained in the 1994 Order, which:

… seeks to adapt the provisions of the 1986 Act piecemeal in order to accommodate the procedures applicable on the winding up of an insolvent firm, whether in conjunction with or independently of the insolvency of one or more of the partners. The product of this approach is an indigestible patchwork of provisions, some of which are in certain respects ill-suited to their task.^[58]

3.56     Parallel with our work, an ad-hoc joint sub-committee^[59] has been set up by the Insolvency Courts Users Committee in consultation with the Law Commission, to consider the treatment of insolvent partnerships and offer recommendations which can be considered alongside the Law Commission's report. A consultation paper making proposals for reform was issued at the beginning of 2002, the results of which have yet to be formally reported to the committee. The main points of the consultation paper are attached as Appendix D. It is hoped that this work will result in proposals for reform of the 1994 Order, which can be brought into effect at the same time as the proposals in this report.
3.57     In Scotland there are no proposals to reform the rules concerning the treatment of insolvent partnerships. We are not aware of any significant problems with the application of the Bankruptcy (Scotland) Act 1985 and its subordinate legislation to partnerships.

Consequential amendments

The draft Bill does not include provisions for consequential amendments of other legislation, resulting from the proposed reforms. The detailed work necessary for this purpose is best undertaken once the principle of the reforms has been accepted, and at the time when the draft Bill is being prepared for Parliament. Otherwise, work done at this stage may be overtaken by other legislative change. We do not expect the consequential amendments to give rise to significant policy issues. 3.58

Note 1    Prof J J Henning, “The origins of the distinction between loan and partnership”: Company Lawyer (2001) Vol 22 No 3 p 75 to end.    [Back]

Note 2    See the Joint Consultation Paper para 2.29. Such a dissolution, where the business continues, is sometimes called a “technical dissolution”, to distinguish it from a “general dissolution” when the business comes to an end: see M Twomey, Partnership Law (2000 Butterworths Irish Law Library) paras 8.23, 23.07ff. In legal theory, however, there is no difference. (The 1890 Act seems to use the term dissolution in both senses: cf ss 42, 44).     [Back]

Note 3    A “partnership at will” is one in which the agreement contains no provision as to duration: see Lindley & Banks paras 9-01 – 9-03.     [Back]

Note 4    Twomey, op cit p 8.02.     [Back]

Note 5    See the Joint Consultation Paper para 6.19.    [Back]

Note 6    See Part VIII below.    [Back]

Note 7    See para 8.100 below.    [Back]

Note 8    1890 Act, s 39.    [Back]

Note 9    Para 2.10 above.    [Back]

Note 10    See paras 3.50 - 3.53 below.    [Back]

Note 11    Helmore v Smith (1885) 35 Ch D 436, 444, per Bacon V-C.    [Back]

Note 12    1890 Act, s 28 (duty to render true accounts and full information); s 29 (duty to account for any private benefit derived from the partnership); s 30 (duty to account for profits of competing business).    [Back]

Note 13    We also favour the re-enactment of the more specific fiduciary duties (ss 28, 29 and 30 of the 1890 Act: see above) as default rules, which may be modified, but only so far as consistent with the general duty of good faith.    [Back]

Note 14    See eg per Harman LJ: “A model piece of legislation” (Keith Spicer Ltd v Mansell [1970] 1 All ER 462, 463). We also note respectfully the warning of our consultant, Roderick Banks, in his introduction to the latest edition of Lindley & Banks (p vii); he refers to the prospect of a new Partnership Act to replace the 1890 Act “which has stood the test of time so remarkably well” and comments “Would that new statutes were as well and as economically drafted(”    [Back]

Note 15    Higgins & Fletcher, The Law of Partnership in Australia and New Zealand (8th ed, by Keith Fletcher) p 6-7. See also Davis, Steiner and Cohen, Insolvent Partnerships (1996) para 1.3 where the authors describe the 1890 Act as “deceptively clear”.    [Back]

Note 16    See Income Tax Commissioners for the City of London v Gibbs [1942] AC 402, Lindley & Banks, para 3-04.     [Back]

Note 17    1890 Act, s 17(1) and (2).    [Back]

Note 18    1890 Act, ss 17(3) and 18.    [Back]

Note 19    In Scots property law there is no separation of legal and beneficial ownership. In Memec plc v IRC (1998) 71 TC 77, 112 Peter Gibson LJ speaks of the assets of a partnership being vested in a Scottish partnership “legally and beneficially” which is an English lawyer’s analysis of property owned by a Scottish partnership and not held on trust for another person.    [Back]

Note 20    See Memec plc v IRC (1998) 71 TC 77, 112 per Peter Gibson LJ.    [Back]

Note 21    In the United States, a court has held that a successor partnership did not have title to enforce a title insurance policy that had been issued to an “old” partnership: Fairway Development Co v Title Insurance Co 621 F. Supp.120 (N.D. Ohio 1985). This case influenced the drafters of the Revised Uniform Partnership Act (1994) (RUPA) to adopt a default rule of continuing legal personality.     [Back]

Note 22    1890 Act, s 17.    [Back]

Note 23    CPR, Sched 1, RSC O 81, r 1.     [Back]

Note 24    Lindley & Banks, para 14-03.    [Back]

Note 25    In the United States of America, the Uniform Partnership Act (1914) (UPA) met this problem by providing that an incoming partner’s liability for old debts should be satisfied only out of partnership property (UPA s 17). The commentary says that this was designed to solve “one of the most perplexing problems of partnership law”. RUPA seeks to continue this position by the combined effect of s 306-7 (see official commentary to s 306: “In effect, a new partner has no liability to the existing creditors of the partnership, and only his investment in the firm is at risk for the satisfaction of existing partnership debts”).    [Back]

Note 26    Hurst v Bryk is unreported at first instance; the Court of Appeal’s decision is reported in [1999] 1 Ch 1 and the decision of the House of Lords in [2002] 1 AC 185.     [Back]

Note 27    Under the 1890 Act, s 35.    [Back]

Note 28    See the Joint Consultation Paper paras 6.28 – 6.29, Lindley & Banks para 24-10 but see Mullins v Laughton [2003] Ch 250.    [Back]

Note 29    See Part VIII below.    [Back]

Note 30    Case C – 212/97 [1999] ECR I – 1459. The decision characterises a corporation as eligible for the rights of a citizen of its state of origin, including the right to establish a branch in a country outside its country of origin that is subject to its home-state law.    [Back]

Note 31    “The Evolving partnership”: Prof L Ribstein, Journal of Corporation Law Vol 26 No 4 (Summer 2001) p 820.    [Back]

Note 32    Potential users of British partnerships may not be attracted by the risks to an established business of the default rule that a partnership is a partnership at will. As a partnership can become a partnership at will while partners are renegotiating a partnership agreement (see Walters v Bingham [1988] 1 FTLR 260) or through inadvertence on a change of membership, we think that a default rule of continuity will also increase the attractiveness of partnership.     [Back]

Note 33    See paras 6.47 - 6.88 below.    [Back]

Note 34    As well as the special limited partnership in Part XIX below.    [Back]

Note 35    This is subject to the exclusion of contract law doctrines as grounds for breaking up a partnership. See para 8.124 below.    [Back]

Note 36    Partners, of course, will not be able to modify or exclude default rules which have conferred rights on a former partner without his consent. See para 8.81 below.     [Back]

Note 37    We also look to the rules of insolvent winding up in the Insolvency Act 1986, for example in relation to the release of a liquidator by the court on completion of a winding up.     [Back]

Note 38    See Part XII below.    [Back]

Note 39    This was also an important issue in relation to agricultural partnerships in Scotland. See Part XIV below.    [Back]

Note 40    See Part XIII below.    [Back]

Note 41    See Registration of Security Interests: Company Charges and Property other than Land, Consultation Paper No 164. A separate reference is being undertaken by the Scottish Law Commission, which is limited to company charges: see Registration of Rights in Security by Companies, Discussion Paper No 121.    [Back]

Note 42    Ibid Part X.    [Back]

Note 43    Twomey, para 28.08.    [Back]

Note 44    This is so long as he retains limited liability by not involving himself in the management of the business of the firm.    [Back]

Note 45    See para 3.30 above.     [Back]

Note 46    See Part XIX below.    [Back]

Note 47    See Income Tax Commissioners for the City of London v Gibbs [1942] AC 402.    [Back]

Note 48    Value Added Tax Act 1994 (VATA) s 45; for the purposes of liability, a member who has left the partnership is treated as remaining a partner until the Commissioners are notified of the change (s 45(2)).    [Back]

Note 49    “What has to be ascertained is the profits of the firm and not of the individual partners. That is not, I think, stated anywhere in the Income Tax Acts, but it follows necessarily from the fact that there is only one business and not a number of different businesses carried on by each of the partners”: MacKinlay v Arthur Young & Co [1990] 2 AC 239, 249.    [Back]

Note 50    Income and Corporation Taxes Act 1998 (ICTA) s 111: the total sum was treated as “one sum … separate and distinct from any other tax chargeable on those persons … and a joint assessment shall be made in the partnership name”.     [Back]

Note 51    ICTA 1988 s 111 (new form).    [Back]

Note 52    Ibid s 111(2) & (3).    [Back]

Note 53    Taxation of Chargeable Gains Act 1992 s 59: “tax in respect of chargeable gains accruing (to partners) shall, in Scotland as well as elsewhere in the United Kingdom, be assessed and charged on them separately.”    [Back]

Note 54    See Lindley & Banks, para 35-02.    [Back]

Note 55    The VAT treatment of partnerships under the new regime will be dealt with in consequential amendments, which will be prepared by Customs and Excise in due course.    [Back]

Note 56    SI 1994/2421.    [Back]

Note 57    A Scottish partnership can be sequestrated although the estates of the partners are not sequestrated. In practice, it is common that some or all of the partners (if apparently insolvent) are sequestrated at the same time as the partnership. See Bankruptcy (Scotland) Act 1985, ss 6(1) and (5), 7(3); McBryde, Bankruptcy (2nd ed) para 4.20f. Difficulties can arise in petitions to sequestrate partnerships if the separate personality of the partnership is overlooked, but the bankruptcy rules work well if the principles of the Scots law of partnership are borne in mind: McBryde op cit para 4.22. Complex factual issues, which can arise on the insolvency of informal or badly-run partnerships, will continue to arise, whatever rules are applied.     [Back]

Note 58    Lindley & Banks, para 27-01.     [Back]

Note 59    The sub-committee is chaired by Mr Justice Evans-Lombe and its members include practitioners in the field. The secretary to the sub-committee is Mr Registrar Baister, at the Royal Courts of Justice to whom enquiries should be directed (email to sbaister@lix.compulink.co.uk).    [Back]