Forming a farming partnership: legal advice

Becoming or taking on a partner is something to be considered very carefully. An underlying principle of partnership law is that the partners should have utmost trust and confidence in each other.

There is an important reason behind this. In a traditional partnership, each partner has unlimited liability for partnership debts.

This is not to be taken lightly, particularly as each partner has full authority to the outside world to incur liabilities and enter into agreements in the name of the partnership.

See also: Forming a farming partnership: tax advice

Farm partnerships now often include valuable assets, such as land, on the balance sheet (as assets of the partnership) for good tax planning reasons.

Therefore they are not simply trading arrangements but significant asset-holding structures that regulate the ownership of the bulk of a farming family’s wealth. Where this is the case, they have to be approached in a different way.

Jonathan Stephens
Partner
Wilsons Solicitors

Who owns what?

The question of who owns the partnership assets and any increase in their value is quite complicated and widely misunderstood.

Lack of clarity on these points can lead to costly disputes, sometimes with drastic consequences.

Equally, if debt is included on the partnership balance sheet, difficult issues can arise as to how the instalments (part interest and part capital) should be dealt with between the partners.

While profits are shared, so are losses. And there are two sorts of profit – income from the trade and from the increase in capital values or from disposal of partnership assets.

It is also important to understand the difference between partnership assets and separate assets.

Partnership assets are owned by the business and are reflected on the balance sheet. Separate assets belong to one or more of the partners, but are made available for the partnership to use. This distinction is often very important in relation to land.

For example, a partner may be advised, for tax planning purposes, to introduce his land so that it becomes a partnership asset.

In that event, he no longer owns it directly – instead, it is owned by the partnership. The partner has exchanged his land for additional capital in the partnership.

The partnership agreement can provide for the capital value to be allocated to a separate “land capital account” on the balance sheet, to which he is entitled.

The agreement would also provide that he should be entitled to the capital profits arising on an increase in the value of that land.

This treatment means that it remains his for capital gains tax purposes. This structuring can have important tax advantages, but also has significant practical consequences.

A farm partner who has introduced land in this way needs to remember he cannot automatically get it back again. Also, he cannot leave it under his will (because he no longer owns the land but an interest in the partnership capital). These things can be achieved, but have to be thought through and dealt with.

All of these aspects need to be carefully analysed and set out in the partnership agreement and then correctly reflected in the annual accounts.

Work together

Lawyers and accountants need to work together and fully appreciate what is intended by the partners. Practice and terminology varies widely, so it is important not to assume that everyone is thinking along the same lines.

The partnership agreement needs to deal with other vital issues that are often left in the “too difficult” category by family businesses. For example, what happens on a retirement, death, or if someone loses mental capacity?

Not everything can be provided for and flexibility is an important element. Nonetheless, a carefully framed partnership agreement should cover the ground.

Failure to draw up a proper agreement leaves the family and its assets in an uncertain position.

The Partnership Act 1890 would then dictate how assets are valued and distributed – for example, on the death or retirement of a partner – and could even lead to the forced sale of the farm.

The Act applies subject to whatever the partners may have agreed, either in writing or evidenced by a course of dealing. That is where disputes can arise, especially where things have changed over the years but the formal arrangements have not been updated.

Dispute resolution provision

All of this is fairly well-known in the case of trading partnerships.

A great deal of care is required where substantial value is included in the partnership, particularly where land is held as an asset on the balance sheet.

A good starting point is to be absolutely clear at the outset how the land to be farmed is owned and occupied. Is it freehold or rented? Is the asset held within the partnership or separately? If it is to be held within the partnership, does the individual who contributed want it back, or to leave it under their will?

It is surprising how often these things are not dealt with properly. It is important to address these issues when setting up a new partnership, but also to give existing arrangements a thorough review to make sure the partners understand the position and that it accords with their wishes.

What a partnership agreement should include

• Partners’ names and addresses, and the trading name
• Business of the partnership
• Details of partnership assets, how they are held (by individual or the partnership)
• The land occupied by the partnership, and how it is occupied
• Contributions to capital, and any special capital ownership structures
• Rights to income and capital profits (and liability for losses)
• Rights to regular drawings, and an obligation to repay an overdrawn position
• Keeping the books, annual accounts and bank account mandates
• Provision for partnership meetings, and how decisions are made
• Any limitations on authority for individual partners
• How much notice a partner should give to leave
• A right of expulsion
• How a partner can extract his land if he wants to
• What happens on death or retirement