Bringing in a new farm business partner: The legal considerations

As part of Farmers Weekly’s series on farm partnership agreement, this week we look at bringing in a new partner, which is often a significant element in succession planning for a family farming business. 

It is a step up in terms of seniority, and the personal and family issues connected with the decision are probably more important than the legal, accounting and tax ones.

Having open discussions about this move, and managing expectations, are vital. Once made, it can be hard to undo.

The first part of this series features tax advice on forming a farming partnership as well as what legal issues need to be considered before setting up a partnership.

Jonathan Stephens is a partner at Wilsons Solicitors, based in Salisbury. He specialises in structuring issues for farms and businesses.

When is the right time?

Typically it will involve a younger family member, who has been involved in the farming business for a while, moving from being an employee to being one of the proprietors. It means taking responsibility for the business and becoming involved in decision-making.

It involves sharing the assets and the liabilities and, in a traditional partnership, unlimited liability to the debts. So far as the outside world is concerned, each partner has full authority to enter into contracts and incur liabilities.

This makes it important that all partners agree that the person to be introduced is suitable and has the capability to take on the responsibilities involved and that the move is the right decision for the family and the business in the wider sense.

Admitting a new partner is certainly not something to be done in haste, to solve a problem or to try to improve an awkward family situation.

Read more on the tax considerations of bringing a new partner into a farm partnership

Capital contributions and succession

In the context of a family farm, a new partner is not always required to make a capital contribution, but it is common to do so. The new partner’s financial contribution may arise through a gift or inheritance, either immediately or over a period. If a new partner is required to introduce new capital, it may have to be borrowed.

It is important to consider how ownership of the partnership assets will be passed down in a family farming context, and how the land and other capital assets are to be owned. Very often this will involve long-term tax and asset planning.

There usually has to be an acceptance that the farming members of the family will need to inherit enough assets to maintain a viable farming business.

This is generally accepted within farming families, but it is always a difficult issue because the ability to balance interests for non-farming members varies depending on the circumstances.

Take care in making promises in relation to the future. This has proved fertile ground for litigation if aspirations are not met, and this can have disastrous consequences.

Income sharing

A new partner will usually shift from being a wage-earner on the payroll to taking drawings on account of (in the expectation of) profits. He or she needs to understand the difference between drawings and profits, and how the tax is paid.

The individual’s day-to-day cash requirements also need to be discussed, as there may be an expectation that becoming a partner means higher earnings.

A new partner’s profit share might be structured as an agreed prior amount (effectively, a basic salary, although not paid or administered in the same way through PAYE) with a small percentage of profits on top.

If this is done, it can be important to spell out what happens if there are insufficient profits to cover the basic salary.

In the absence of anything else, the new partner would have to pay back the deficit when the accounts are produced. Sometimes a partnership agreement provides that a deficit can be carried forward, hopefully to be cleared in the following years.

Duties and time off

It is important that the roles and duties of each partner are agreed. An individual moving from employee to partner may expect to have more say in what they are required to do.

The partnership agreement should specify which partners are required to work full-time and those with a lesser role. Ideally it should also set out holiday entitlements, although this is in practice rare in a farming partnership.

Even if these are not contained in the partnership agreement, they should be discussed and agreed.

Control and voting

If the partnership agreement does not specify the decision-making process, the general position is that every partner may take part in the management of the business.

In the absence of anything in the agreement, “ordinary matters” are decided by majority (section 24(8) Partnership Act 1890). These involve most decisions that relate to the way in which the business is conducted on a day-to-day basis.

Any matters outside this (for example, a change in the nature of the partnership business) would need unanimous agreement. Where there is a deadlock, and the matter went to court, the general rule would be in favour of maintaining the status quo.

In the context of a family farming partnership where the older generation is handing over to the younger, key older partners may want to retain certain powers of veto for a period.

Limits on authority

A partnership agreement can set out limits on an individual partner’s authority to incur expenditure over a certain limit, hire and dismiss staff and so on.

Those limits bind the partners between themselves, but are not binding on a third party such as a supplier, unless that third party knows about the limits, which is unlikely.

So, for example, if a partner with authority to make decisions on partnership spending up to £10,000 commits the business to spending £20,000, the partnership is likely to be committed to that transaction.

Legal rights of a new partner

A new partner has all the rights under the Partnership Act 1890, as varied by the partnership agreement. Each partner has a duty of good faith to all the others.

In the case of a dispute, a partner has a number of rights and remedies which would not have been available before, including a right to have the partnership wound up if it can be shown to be just and equitable to do so.

How a new partner is admitted

A document supplemental to the partnership agreement is drawn up. This is usually called a deed of admission and should detail the full name and address of the person joining the business and the terms on which he is joining.

It can also cover any amendments to the agreement, for example changes to clarify ownership of specific partnership assets now that an additional partner is involved.

New partner – important considerations

• Do not act in haste – is the appointment being made for the right reasons?
• Is the person suitable and capable – would some formal business and/or agricultural education help before the move is made?
• Partnership is an important move – as well as the new partner understanding his obligations, existing partners must fully accept the newcomer and include them in decision-making, unless the partnership agreement says otherwise.
• Be wary of promises – don’t raise expectations unless you mean to follow through on what you have said.
• Being a partner means sharing not only profits, but losses too – this needs to be clearly understood by a new partner.
• Be clear on roles, working times, responsibilities, holiday entitlements, limits on spending or selling on behalf of the partnership.
• Ideally the partnership agreement should set out how decisions are to be made.
• Each partner has a duty of good faith to all the others and ultimately can call for the partnership to be wound up.
• A deed of admission should be drafted to record the admission of a new partner and any related partnership agreement changes.
• Once appointed, the new partner’s name should appear on the letterhead and notepaper of the business, alongside those of all the other partners.
• Inform the bank, HMRC (including VAT) and your insurer of the change.