Tuesday, July 2, 2013

Preparatory activities and the commencement of a partnership

Section 3 of the Partnership Act, 1932 defines a partnership as the relationship between “persons who have agreed to share the profit of a business carried on by all or any of them acting for all”. This formulation shows that mere agreement is not enough: there must be a business which is carried on. The English Act of 1890 defines a partnership as the relationship that subsists between persons “carrying on a business in common with a view of profit.” This formulation often gives rise to the question: when is a business said to have been ‘carried on’?

Identifying precisely when the partnership relationship commenced can be important for a number of reasons: sometimes fiscal, and occasionally because partners fall out at an early stage of their relationship, making it necessary to decide whether the assets acquired until then are held for the purposes of the partnership or not. The leading case on this subject is Khan v Miah. Two persons, employed respectively as the head waiter and chef of a restaurant, decided to open their own Indian restaurant in Berkshire. In order to finance the venture, they approached Mr Khan, who agreed to put up the necessary capital for a 50 percent share of the profits, the remainder to be shared by the Miah group and a sleeping partner. The parties took a number of steps towards opening the restaurant before they fell out: for example, they acquired the freehold of premises identified as suitable for the restaurant, obtained planning permission, entered into contracts for the laundry of table linen and secured a loan of £60,000 from a bank. About two months before the restaurant opened, Mr Khan fell out with the other partners and exited the venture. The question was whether he was entitled to a 50 percent share. The House of Lords held, unanimously, that the Court of Appeal had applied the wrong test in asking whether the restaurant business had commenced: what is important is not whether there is trading, but whether the partners have embarked on the business activity in question. Lord Millett said that merely establishing the business vehicle and the management structure is not enough, but embarking on any commercial activity, such as acquiring property or incurring liabilities, towards the joint venture is. Lord Millett gave the example of the film production business: it is necessary to incur substantial preparatory expenses before the film is produced, such as the cost of commissioning a script, engaging a camera man, paying the cast etc, but that does not mean that the business activity has not commenced.

In applying the Khan v Miah test, it is important to closely analyse the particular business venture the parties have agreed to carry on, and then ascertain whether the activity actually embarked on is part of that venture. In other words, Khan v Miah is not authority for the proposition that any type of preparatory activity triggers a partnership. This issue was recently considered by the Court of Appeal in Ilott v Williams. Mr Ilott and three others (to whom Arden LJ refers as ‘the Four’) decided to establish the business of managing investments but did not have the funds to do so. They ‘pitched’ the idea to several potential investors, one of whom was Blue Crest Capital Management [“BCM”]. BCM executed a Side Letter confirming that the Four would be admitted as limited partners of BCM, and entitled to 40 % of the profit. By 30 November 2011, the Four had generated profits of about £19 million. Four days prior to this, BCM had served on Mr Ilott (as it was entitled to do under the contract) a Notice of Removal. Mr Ilott ceased to be a member of BCM. He brought a claim for his share of the profits against the other three members of the Four and also against BCM. The claim against the Four was framed in partnership and his case was that there was a partnership (in parallel to their membership of BCM) because the Four had agreed to share the profits distributed to them by BCM in terms of the Side Letter.

Arden LJ rejected this contention, pointing out that Khan v Miah did not eliminate any distinction between preparatory arrangements and partnership”. Accordingly, a conclusion at first instance that the activities the parties had carried on did not constitute a partnership will not be disturbed unless it was clearly wrong:

The parties had a concept for a new business but as of April 2008 they had no means of creating any profit, and they had made no financial commitment apart from buying a domain name.  The judge did not make a finding as to the cost involved in acquiring the domain name but there is no suggestion that it was significant.  There is no evidence that any of the Four sought to bind the other members of the Four.  There was no agreement as to the business form which the Four would adopt for their business.  There was no assurance of funding or of having the means to obtain regulatory approval.  The questions of external funding, business model and regulatory approval were regarded by the parties as vital pieces of the jigsaw.  In my judgment the judge was entitled to conclude that, without them, the parties were not bound together as partners.
What this means is that the activities actually undertaken by the ‘partners’ must be capable of properly being characterised as part of the business venture they agreed to carry on. Apart from the fact that this enquiry depends on the nature of the business, there were numerous factors in Ilott inconsistent with a partnership: the desire of the Four to use limited liability in whatever vehicle they chose, the receipt of funds from BCM to the Four simply as a matter of convenience, and the fact that parties are unlikely intend to establish a partnership simply to receive the fruits of a business that is carried on through another business vehicle.

1 comment:

A QUACK said...


Even without reading the write-up down to the last word of it, or minding to make a sudy of the cited court views, one is left with an impression (open to correction if wrong) that, - unless and until a partnership is in a position to take forward and carry on its business activities, according to a view, there is scope to question the very coming into being or existence of a 'partnership' itself.
If so, and that be the right premise to understand the advanced proposition, then prima facie, to say the least, it is too confusing to be readily appreciated, much less sanely accepted, to have any substance or merit whatsoever.
What instantly come to one's mind, requiring to be kept in the backdrop for analyzing the proposition are, in brief, these:
The well known and widely heard of concepts, mutually exclusive or related or otherwise, in relation to the basic concept of 'business' itself, namely, - 'set up', 'actual commencement of business activities’, and 'interregnum' between the two events which is inevitable and hence to be taken for granted, the others being 'dormant' and 'defunct'.
The other facet to be necessarily borne in mind and examined are, - applicability or otherwise, or extending the same line of thinking via a vis other entities namely; 'corporate', LLP; more importantly, and if were taken to apply, the deleterious consequences and repercussions that would lead to /result.
These are simply hints thrown up at random, which might be worthwhile to be kept in focus, for those law exponents and pundits interested in going into the subject matter any deeper.
(May be contd.)