What happens when a business partner dies?

Unfortunately, I have seen many situations involving emotional and financial stress, legal implications and costs when a partner of a business dies.

There are still many thousands of small businesses which are started informally between 2 people and for whatever reason, as the business develops, the partners do not get around to putting in place a written partnership agreement. It is perhaps understandable (although certainly not recommended) that at the very earliest stage of business, for costs or other reasons, the partners do not consider the risks and the need for a clear written agreement. However, as the business grows, consideration should be given to having a clear written partnership agreement.

Any existing partnership agreement should, like a will, be reviewed from time to time and, if necessary, amended to take account of any significant changes in the partnership, although a well drafted original agreement should have longevity.

If you are in a business partnership and any of the above or below scenarios apply to you, I can help. Please get in contact with me.

Case Study

I was consulted by a very successful businessman (annual turnover over £3m and very healthy profit), whose co-partner was diagnosed with cancer in the previous year and had sadly passed away a month previous to seeing my client. He generously allowed his partner time out of the business without loss to his share of profits.

The problems

Unfortunately, the deceased partner was not very good at handling his personal financial affairs and his widow was now chasing my client for a payment of all that was due to her late husband’s share of the business.

More unfortunately, though the business was successful, by its nature and custom, the business allowed trade credit for a period of around 6 months. That meant that it had to wait some time before it got paid by its customers (primarily, 3 very large institutions). Worse still, there was no insurance protection to cover the risk of a partner dying.

Moreover, there was no partnership agreement.

The 2 partners just went on amicably without creating rifts and paid themselves as and when the business allowed them to. They were equal partners; both had contributed equally to the business in terms of capital and had accepted to share the profits and losses equally.

No Partnership Agreement – often everyone loses out

It is possible to set up a partnership without having a formal written partnership agreement and rely on an implied agreement on many issues (i.e. relying on a course of conduct) but certainly not desirable.

In the absence of an agreement the Partnership Act 1890 contains “default provisions”. For example, the death of a partner results in the dissolution of the partnership (i.e. it brings it to an end)!

Further still, there being only 2 partners, the surviving partner (my client) has the responsibility of winding up the business. In short, he would have to run the business to complete any unfinished contracts, not take on any new business, pay off debts and then distribute whatever is left. If, in the course of this process, there is not enough to pay off all creditors then the surviving partner and the deceased’s estate will be liable for the shortfall.

This may well not be what the partners or their respective families might have wanted or intended to happen, let alone the substantial damage to the finances and goodwill of a business or the considerable time to sort it all out. For example, obtaining a grant of representation (i.e. probate) to the deceased partner’s estate can take some months to achieve. In a partnership agreement provision can be made for payments to a dependent of the deceased partner commencing shortly after death. These are usually discretionary on the part of the surviving partners and set against the deceased’s partners share of the partnership but have the advantage of not requiring probate to be obtained first so that some provision for a dependent can be made at a much earlier stage than might otherwise be the case.

Financial Traps

The provisions in the Partnership Act also determine how the debts of the partnership are to be born and the distribution of the partnership assets on winding up. Unless you have looked at these provisions beforehand this may come as a considerable shock e.g. after payment of the debts and liabilities of the firm and repayment of capital and advances to partners, the residue is divided between the partners in the proportions in which profits are payable. This could result in a partner who receives an equal share of the profits by agreement, but who has not put in as much capital as the other partner/s receiving a larger share than was intended.

A properly drawn up written agreement can overcome these potential problems by providing that the partnership will continue between the surviving partner/s, making cash flow and tax efficient provision for the transfer of the deceased partner’s share and providing for the distribution of assets on dissolution and winding up.

Delays

In my case study, it took nearly 3 years to wind up the business. Accounts had to be prepared as at the date of the deceased partner’s death (dissolution accounts), for each annual accounting periods following his death (whilst the business was being wound up) and winding up accounts that dealt with the financial position on actual winding up of the business.

Unfairness – surely neither partner would want that?

In the course of events, my client was involved in a number of disputes, including the time and effort that he had spent in winding up the business. Though the law allows him to be rewarded, it is not clear how much that reward should be.

Also, because there was no partnership agreement to state that the business could continue and be taken over by my client on the death of his co-partner, the years that they had both put into building it up were lost. The business had to be shut down and my client had to start all over again building up a new business.

Why didn’t the partners have an agreement?

I asked my client why he had not entered into a partnership agreement and taken proper advice early on. His response was that he had known his deceased partner for years both as a friend and in business connections. As with many new businesses there was a lot of expense involved in setting up the business and because of the trust and common understanding between them they had sought to save a little on legal costs. Unfortunately that had resulted in my client suffering the full burden of dealing with the winding up of the business on the death of his business partner, starting business life again and a lot of emotional and financial turmoil for not only his family, but also his deceased partner’s widow.

Proper and experienced legal advice – a relatively small price to pay.

Sometimes, I have to remind my business clients that they take out insurance for things that they treasure and want to protect, for example, their family home, their car/s, their business insurances etc. In doing so, they cover against the risk of loss by way of annual premiums for a very long time. I make the point that their business is what generates their financial well being and, in no different manner, it should be protected. However, the point that I clearly make is that the cost of setting up a robust Partnership Agreement is relatively small compared to the insurances I have mentioned. This is because a robust agreement will usually survive many years but only requires a single payment in terms of legal fees. A small price to pay for peace of mind and avoiding what could be a gruelling nightmare

Succession planning is always important to a business and best dealt with proactively, not reactively. A properly drawn up partnership agreement can make that planning much easier.

If you still haven’t finalised your last wishes or would like to advice on dealing with the death of a business partner, how to write a new will, how to leave money in trust for a young relative, or if you are struggling with probate issues, call us on 03456 381381. Alternatively, email us at estatemanagement@ibblaw.co.uk.