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Farming Partnerships - common pitfalls

Close up barley

Partnerships continue to be a popular structure to run a farming business in Scotland because of the flexibility they offer and the relatively low level of regulatory reporting requirements compared with other business structures.

In Scotland, a partnership has a separate legal personality distinct from the partners.

However, there are various common issues in relation to this business structure which should be considered. This is especially true when planning for succession or any change in the farming business or any partner’s circumstances. As most of the farming business run in partnership family businesses, there is opportunity for disagreement and dispute as a result of family dynamics and agreements which have not been kept up to date.

Where there is no written partnership agreement in place or the partnership agreement is silent as to particular issues the Partnership Act 1890 applies certain default rules which may not have the effect you wish or be suitable for your business.

Please note the following scenarios address certain common pitfalls but do not constitute legal advice. Where you have concerns about farming partnerships or succession planning you should take independent legal advice at the earliest opportunity.

The importance of Partnership Agreements

What happens if a Partner Dies?

Mr and Mrs Farmer are operating their farming business as a partnership “at will” with no written partnership agreement in place. They have three sons, two of whom are involved in the farming business and one who is not. Mr and Mrs Farmer are the only two partners in the business. What happens to the partnership if one of them dies?

Effect

As there is no written partnership agreement in place, the provisions of the Partnership Act 1890 operate as a default and under the terms of the legislation the partnership ends on the death of any partner.

In addition, because by definition in the 1890 Act a partnership requires a minimum of two partners, the partnership ends on the death of either partner by default and the surviving partner becomes a sole trader as a result.

On being advised of the death, the Bank freezes all the partnership accounts and the surviving partner (now a sole trader) cannot access funds for payment of ongoing business operating costs.

How to avoid

  • Have a written partnership agreement which provides that the partnership is to continue following the death or retiral of a partner or the assumption of a new partner.
  • Have more than two partners in position – consider bringing in the next generation to allow continuity of the business.
  • Review arrangements regularly.


What is each Partner’s Share?

Mr and Mrs Farmer realised the pitfalls which existed under Scenario 1 and put in place a written agreement which assumed two of their sons into the partnership. They were concerned that one is still immature and did not wish him to have control over a 25 % share of the partnership assets, but they did not wish to offend him or to make a difference between the two brothers so did not specify the shares in the Partnership Agreement or provide that they could be adjusted by agreement between the partners.

Effect
Where a Partnership Agreement is silent as to shares, partners are entitled to share equally in the capital and profits of the partnership and must contribute equally towards losses. Both sons therefore have control over a 25% share of the partnership assets, regardless of the wishes of Mr and Mrs Farmer.

How to avoid

  • Ensure that there is written provision in the Partnership Agreement if shares are not to be equal.
  • The shares can easily be amended at a later date and provision can be made that the partners can agree this.
  • The default rule is that each partner has one vote. Consider providing for voting rights in the Partnership Agreement for certain business decisions.
  • Have the hard conversation about succession and expectations within the family early on.


What happens if a partner no longer has capacity?

Mr and Mrs Farmer and their two sons are in partnership and operating the farming business. Mr Farmer develops dementia and is unable to continue to work.

The Partnership Agreement is silent on what is to happen in the event of incapacity of a partner.

In Scotland, s 35(a) of the Partnership Act is still in force. This allows a court to order the dissolution of a partnership based on a partner’s mental incapacity.

Effect

There is no other option than dissolution, which may not be what the remaining partners wish and which will have an effect on business continuity.

How to avoid

  • Incorporate a clause into the Partnership Agreement which permits the partners to serve notice on a partner in relation to whom the court has made an intervention order or guardianship order under Part 6 of the Adults with Incapacity (Scotland) Act 2000 as this allows for more flexibility.
  • Provide a time period for remaining partners to buy out any partner’s share on retirement, death or incapacity.


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