Farm partnerships – why a written agreement is essential

The value of a well-drafted partnership agreement becomes apparent when there is a dispute, or when a partner leaves, retires or dies.

A partnership agreement can be thought of as an insurance policy in case things don’t go as expected, especially where there is a dispute or partnership breakdown, says Andrew Holden, head of rural at law firm Napthens.

See also: BPS phase out means contract farming agreements need new approach 

Where there is no written partnership agreement, the Partnership Act 1890 sets out what happens. This includes the dissolution of the partnership on the death of any of the parties involved.

“This can mean all debts would need to be settled, borrowings returned to banks, and the residue distributed between the remaining partners,” Mr Holden says.

However, in most circumstances, as long as the parties agree, a new partnership agrees to take over all debts and assets of the old partnership and there is no sale or distribution.

“A written partnership agreement can also help reduce the chances of a dispute, and provide the mechanisms for how a dispute is to be settled,” Mr Holden says.

Lenders increasingly want to see a well-drafted partnership agreement before they agree to new lending.

They also generally like to see a new partnership agreement when a new partner is admitted, to make sure that person is also liable for the existing partnership debts.

However, Mr Holden says many farming families still operate partnerships without an agreement, or with a poorly drafted document.

The basics of a good partnership agreement include:

• Provision for the partnership to continue when a partner retires, dies or otherwise leaves.
• A list of partnership assets.
• How profits will be shared – both income and capital.
• How an outgoing partner’s share in the assets is handled. It is common for remaining partners to have an option to buy that share but the terms must be considered. Should this be at book value, market value or any alternative method of valuation? Also, the agreement should say whether payment for the share is to be made as a lump sum or instalments, and over what period. Partners may want to state who should conduct any valuation and whether their decision is binding.
• How to deal with a voting deadlock.
• How to remove a partner who may have lost capacity.
• How new partners can be brought in – they do not automatically have to have a capital interest in the partnership.
• Setting out business spending limits for junior or other new partners.

Personal or business assets

Wayne Horrex, manager at accountant Ensors, stresses that it is important to be clear which are personal and which are business assets belonging to the partnership. This can be set out in a partnership agreement.

“It is often assumed that including the property in the annual accounts demonstrates that this is partnership property, but without documentary evidence to support this it can be challenged by HMRC,” he says.

“This is important for inheritance tax reliefs. Where a farming partnership is wholly or mainly trading, then partnership property will be eligible for full Business Property Relief (BPR).”

However, only 50% BPR is available where property is owned personally by the partners and used in the farming trade of the partnership. Agricultural Property Relief applies only to assets used for agricultural purposes and covers only the agricultural value, which may not be the market value, he points out.

It is also important that wills and other ­documents dovetail with the partnership agreement.

Mr Horrex says: “If land and property is included as partnership property it can no longer be gifted in a will. However, an interest in the partnership can be left in a will.”

Partnership documentation should be reviewed regularly and, at the very least, on the purchase of new land or significant assets, or the introduction of new partners, he advises.

Rise in litigation

Julie Robinson, head of rural at law firm Roythornes, points out that unless a partnership agreement is comprehensive, then the Partnership Act will give the lead on any matter on which a written agreement is silent.

The rise in land values has led to increased litigation on partnership terms between family members in recent years, says Ms Robinson.

Lack of clarity over the method of valuation is a relatively common problem, as in the Ham v Ham case (see panel below).

Ms Robinson says agreements should also consider the unexpected, such as the death of a member of the younger farming generation before their parents or other older partners.