This article is written by Prateek Giri Goswami, pursuing a Diploma in Advanced Contract Drafting, Negotiation, and Dispute Resolution from Lawsikho.
The first step to start any business is to create a legal identity such as incorporating a company, limited liability partnership (LLP), or a partnership firm. When two or more individuals seek to commence a business together, it is necessary to explicitly define the legal relationship between themselves for the better understanding of duties and rights of each individual with respect to their business, and for this purpose individuals ordinarily enter into a partnership agreement to clearly define their scope of rights and liabilities. This article will aim to emphasize the important aspects of a partnership agreement and what are the important clauses that are required to be incorporated while drafting a partnership agreement.
What is a partnership agreement?
Although a partnership is governed by the Indian Partnership Act 1932, it provides the basic legal framework for the relation between two or more individual entered into a partnership, however, it is beneficial for the partners to create a personal agreement inter-se, to clearly define the basic details of the business and the correlated rights and liabilities towards their business, such agreement is called a partnership agreement.
The essential clauses to be incorporated while drafting a partnership agreement
The clauses of a partnership agreement can be defined into 4 parts for better understanding they are as follows:-
- The first part of the agreement will provide the detailed information of the Business for which the partners have entered into a partnership agreement, the general clauses under this are:-
- Name and place of the partnership firm: Two individuals may have a different kind of partnership with respect to various business, hence, it is advisable to clearly state the name of the business/partnership firm as it provides a fictional identity to the partnership, similarly, to mention the registered place of the firm is also necessary to mention because all the official correspondence and communication will be received or originate from the official registered place.
- Nature and Scope of business: The business needs to be defined properly because all the rights and liabilities are related to the business only, it should include what is business-related to for example the business is of Manufacturing of Bottles and the purpose is to sell it other business entities (B2B Model), the business will be having both online and offline presence. If nature and scope are complex and require a detailed explanation, then a schedule can be incorporated clearly stating the aspects of the business. Further, it can also be added that the partners by convening meetings and mutual agreement can exclude or include anything in the nature and scope of the agreement and the same will not render the agreement unenforceable.
- Duration: The term period of the partnership agreement must be defined along with the provision for renewal.
- Registration of partnership deed under the Indian Partnership act 1932: A partnership firm is a separate legal entity, which means that the partners can sue and will be sued in the name of the firm, it is pivotal to get the deed registered in accordance with the law as it bolsters the legal sanctity and identity of the firm. Once the deed is registered, it is easier for partners to sue others in the name of the firm. Therefore, the deed must have a clause stating that the deed shall be duly registered within XYZ days upon execution and the same rule shall be applied in the event of any amendment in the deed.
2. The money aspect is the cynosure of any business, and any ambiguity with respect to finances can cause a plethora of disputes and animosity between the Partners hence it is imperative to explicitly define the money aspect of the partnership in detail and preclude any uncertainty. Hence, the second part of the agreement will deal with the information with respect to financial aspect such as:-
- Contribution: To clearly define the total amount of money that has been contributed by each partner. For example, A and B both have contributed INR 50,000/- each for the business making the total capital of the partnership firm INR 1,00,000/-.
- Profit/loss ratio: To define the ratio or percentage as to how the net profit/loss will be distributed among the partners.
- Drawings by partner: It is necessary to mention how much money a partner is allowed to draw from the business for personal use, so as to restrict any unreasonable or excessive withdrawal that can adversely affect the business, each partner cannot draw more than INR 5,000/- in a month from the business for personal use and the same shall be properly inserted in the accounts books.
- Interest on capital: Business can be unpredictable, sometimes a partner may be required to contribute additional funds, and such additional contribution will be considered as a loan subject to interest on returns, however, by the virtue of the agreement, the partners can decide a limited interest rate such as 10%, also an interest-free time period can be decided such as if the partner additional contribution was for less than six months then no interest will be incurred.
- Procedure for borrowing: It is necessary to remember that a partnership comes with unlimited liability, therefore, the decision to take a loan affects all the partners. It is imperative that the procedure of borrowing from banks or other financial institutions shall be decided unanimously and in writing.
- Accounts: The firm shall have a separate account for all the transactions in the name of the firm, it is incumbent upon the partners to ensure that all the accounts books ledgers are adequately maintained and documented. Furthermore, it should be explicitly mentioned in the agreement as to when the annual accounts will be conducted, and on the basis of the same, the distribution of profit or loss will be calculated.
3. Role of partners
- Duties of each partner: This clause is the cornerstone of the partnership deed because the very fabric of the partnership depends upon the acknowledgment of the Duties by their Partners, and it needs to be comprehensive. Some common duties are to promptly pay the contribution, to return any amount received in the name of the partnership, to make every effort to promote the business, to maintain transparency among partners by clear communications, etc.
- Acts forbidden: Whereas the duties and liabilities clause provides a general outline of the responsibilities of the partners, an additional clause which succinctly states the acts forbidden can help in bringing certainty to the role of the partners, this clause will contain acts that are prohibited that may be subject to the consent of all the partners.
- Full time: It is important to acknowledge the devotion of each necessary for the business, and for that, a clause can be included stating that the partners shall devote their full time the business solely and shall not endeavor into any other separate business unless consented by the fellow partners, this clause can also be included in the duty’s clause.
- Non-compete: Upon the departure of any partner from the firm due to termination or retirement, the Partner shall not be allowed to engage in any business similar to that of the partnership firm.
- Confidentiality: A business can be based on unprecedented intellectual property, secret ideas, business models, also there can be various sensitive business deals that are confidential in nature. It is a surviving obligation of the Partners that they are required to maintain confidentiality even if they cease to be the partner of the firm.
- Admission of a new partner: The procedure of adding a new partner must be defined.
- Retirement of partner: Procedure as to how a partner can retire from the partnership and the corresponding obligations. For example, a partner is required to give 3 months’ notice before retiring.
- Expulsion of partner: Events that will be construed as a breach of agreement and entitles other partners to terminate the wrongdoer partner. Also, the insolvency of a Partner will by default lead to the expulsion of the partner.
4. Rights of the partnership firm
- Intellectual property: As mentioned above, a partnership firm deems to be a separate entity, therefore, all the property whether tangible or intangible will be solely owned by the Firm, this clause must state that all the IP created during the business shall be owned in the no Partner can claim his rights over it.
- Goodwill: Similarly, the goodwill of the partnership firm also resides with the firm.
- Dissolution: In the event, the partnership does not follow its ordinary course of cessation by the completion of the term period, a process shall be pre-determined in the agreement for the dissolution of the firm and the firm will wind up and assets will be distributed in accordance with the Indian Partnership Act 1932.
The clauses mentioned above are common clauses available in almost every partnership agreement, it is pertinent to mention that boilerplate clauses such as a waiver, severability, dispute resolution, assignment, heading, counterparts, entire agreement, etc are implied along with the clauses discussed above. However, given the current dynamics of the business world and the involvement of young people with little assets creating start-ups, the lawyer can create an agreement suitable and flexible in accordance with the needs of the Partners, what is most important is that the interest of the Partners and the firm must be secured, any agreement drafted must be in consonance with the governing law.
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