Many of you will have met Joel Woolf, of Joel Woolf Rural Consultancy, at the 6th Annual Conference. He has kindly supplied a copy of the following short article on the recent judgment in Morton v Morton:
Morton v Morton – Clarity on s42 of the Partnership Act 1890
The Morton family are now no strangers to the inside of a court room. This farming family from Cheshire are an exceptional example of what can go wrong in farming families and why leaving it to chance is no sensible strategy.
The recent Court of Appeal judgement ([2023] EWCA Civ 700) however is of significant assistance to understand how and where interest on a partnership share becomes payable on the retirement or other departure of a partner (i.e. through death) from a partnership, and the judgement amounts to considerable guidance on the drafting of provisions in such options.
The appeal related to the interpretation of section 42 of the Partnership Act 1890. It is worth quoting that section in full:
42 Right of out-going partner in certain cases to share profits made after dissolution.
(1)Where any member of a firm has died or otherwise ceased to be a partner, and the surviving or continuing partners carry on the business of the firm with its capital or assets without any final settlement of accounts as between the firm and the outgoing partner or his estate, then, in the absence of any agreement to the contrary, the outgoing partner or his estate is entitled at the option of himself or his representatives to such share of the profits made since the dissolution as the Court may find to be attributable to the use of his share of the partnership assets, or to interest at the rate of five per cent. per annum on the amount of his share of the partnership assets.
(2)Provided that where by the partnership contract an option is given to surviving or continuing partners to purchase the interest of a deceased or outgoing partner, and that option is duly exercised, the estate of the deceased partner, or the outgoing partner or his estate, as the case may be, is not entitled to any further or other share of profits; but if any partner assuming to act in exercise of the option does not in all material respects comply with the terms thereof, he is liable to account under the foregoing provisions of this section.
At first glance the sections appear straight forward. In s42(1) Parliament considered it reasonable and just that where the business of a partnership was carried on after the retirement or death of a partner then the retirement or deceased partner should be entitled to either a share of the profits or interest at 5% per annum. Given the nature of many partnerships, interest is probably by far the easiest to calculate and, until very recently probably also more attractive given savings rates. The election to either a share of the profits or interest is available unless the partnership agreement states something to the contrary. This is consistent with the rest of the act in that the Partnership Act effectively provides a baseline agreement between partners unless they have expressly agreed something else in writing.
Although the Court of Appeal gave commentary on s42(1), it is s42(2) which is the meat of the decision. The various parts of s42(2) were considered in turn. For s42(2) to be engaged there must first be an option for the continuing partners to purchase the interest of the outgoing or deceased partner. That option must have been duly exercised and where it is, there is no right to interest or a share of profits. This makes sense because the terms of the option should include the payment terms and should be set out in full within the partnership agreement.
However, interest can become payable where there is a material breach of the option. What is material will be a matter of fact and circumstance in each individual case, but it can be seen that s42(2) effectively provides a form of default interest although if the partnership agreement contained provisions for interest to be paid in default, then the author would posit that it is likely that the contractual provision will prevail over the statutory provisions.
So, what does the judgement of the Court of Appeal tell us in this case. The author considers that there are two lessons for those who advise on and draft partnerships.
The first is that it must be understood the difference between an option to purchase within a partnership agreement, and the position where on the retirement or death of a partner, where the retiring partner or their estate are simply paid out the value of the relevant share of the partnership belonging to the departed partner. This was a distinction drawn by Lord Justice Lewison at para 65. It is key to understand when considering the nature of a partnership and its assets which of an option or an implied contract for sale is the better solution. For many farming families an option is not the way to go. For a business which heavily relies on the expertise of a single partner then it might be that an option to purchase is sensible on the retirement or death of that partner, as the remaining partners may want to consider carefully whether they wish to continue the business or wind it up.
The second lesson is the drafting of the partnership agreement itself to make sure that there is no ambiguity or missing clauses. Regardless of whether the partnership agreement contains an option or not there will in essence be a requirement for the remaining partners to introduce capital to the partnership in order for the partnership to pay out the capital value of the departed partner.
This starts with being able to identify what the partnership assets actually are, how to value them and then how to calculate the relative shares of the partners and thus how much must be paid to the retired partner or their estate. How that eventual sum of money is raised is a matter for the remaining partners. How the money is paid, the payment terms, should be clearly set out within the partnership agreement together with any period over which payment is made and whether or not interest is payable and at what rate. There must also be consideration given in the drafting to what is to happen if things go wrong.
Although the Court of Appeal distinguished the case on its facts, it nonetheless contains a clear lesson that the less ambiguous the partnership agreement, the less likely a dispute will arise which requires determination in the courts.
Joel Woolf Rural Consultancy – 28 June 2023
Contact: 07896757957
Email: joel@woolfrural.co.uk
Website: www.woolfrural.co.uk