Partnership Disputes, Conflict Resolution & Partnership Agreements
By Professor Kim Lovegrove
18th March 2011
One of the most common areas of disputation in the commercial arena concerns partnership disputes. Be they lawyers, doctors, builders or accountants invariably when partnership relationships deteriorate those that were once bedfellows reach for the partnership agreement. Often when this occurs things get worse. Reason being the agreement hasn’t addressed the issue of how to resolve a dispute or worst case (but not unlikely) scenario the agreement does not provide any road map on how to part ways with a minimum of disquiet.
As sure as day follows night, it is an irrefutable fact that partners will in the fullness of time part ways. Assuming that a partnership proves successful sadly, any given partner is ultimately shackled with mortal tenure, because people die, so even in a utopian partnership there is indeed a finite duration for every one of the natural person partners.
More often however partners leave after a period of years. The causes can vary from moving on to greener pastures, retirement, staleness, a partner not hitting contractual KPI`S or acrimony. A partnership is a dynamic and to a degree an organic concern.
In this article we do not pretend to answer all the questions – that would be impossible. Impossible because partnership agreements have to be purpose built for the type of business and the dispositions and pathologies of the partners. Rather the article is designed to raise issues that can present themselves and to canvass some of the characteristics that make for a good partnership agreement.
Why are partnership agreements drafted so badly?
Partnerships are a bit like marriages. When one goes into partnership foremost in one`s thinking is not divorce, there is an assumption or an implied term that like a marriage the partnership will endure. Often partners are friends, sometimes relatives and the euphoria associated with the perceived benefits of the forthcoming collaboration override the faculties of circumspection and pessimism. After all if people neither liked each other nor trusted each other they wouldn’t go into partnership, let alone entertain it.
Because of the flush of good will that invariably characterizes the augmentation of a partnership, partners are by and large reluctant to apply the necessary discipline to the formulation of the agreement. They find it uncomfortable, just like those intent upon marriage become churlish when it comes to writing up marital prenup agreements. Little wonder the most undercooked element of the partnership agreement is invariably the exit clause.
When drafting a partnership agreement start at the end and consider the worst case scenari?
When we prepare a partnership agreement, be it for clients or ourselves, the first provision we draft is the exit provision or the parting of ways clause. This clause will stipulate that in the event of a partner wishing to migrate or retire certain things will occur, and to cite a few:
If there is a value to his/her/its share spell out what it is. How will he or she be remunerated upon departure or will the provision say that in the event of a partner moving on then there will be no remuneration or consideration upon their cessation. Some clauses say that regardless of the circumstances pertaining to a partner’s departure neither the exiting partner nor the remaining partners will be under any obligation to pay the others any compensation of whatsoever nature. If this position is stated in the agreement it will be binding.
What happens with the partner’s clients, do they migrate with the outgoing partner? How will one determine which clients belong to whom?
One provision that I drafted provided that when a partner leaves, s/he is allowed to migrate with their own clients. To ascertain such identity a list would be drafted by the outgoing partner, that list would be put to the other partners and in the event of disagreement the managing partner in cohorts with the migrating partner could contact the clients directly to ascertain their intentions and preferences. In our experience in instances where this clause has been in existence and was invoked there was indeed a peaceful migration.
One also needs to consider the ramifications of plant and equipment that has been bought during the term of the partnership. We drafted one provision that provided that upon departure, the migrating partner would prepare a list of items that s/he considered could likewise migrate, present it to the other partners and in the event of any disagreement a mediator could be wielded in as the circuit breaker. Again we have experienced the application of such provision and the “divvy up” occurred without controversy and resort to mediation was not necessary.
Mediation clauses are critical
A good exit clause will always have a mediation clause as the last thing one wants is for the matter to end up in the courts. If a partnership agreement is opaque on the matter of dispute resolution, warring partners will end up in the courts.
Why courts are ill suited to partnership dispute resolution
Partnership altercations often involve highly personal considerations. I can recall one matter where one of the parties stated that if the matter went to court, mention would be made of the other party’s sexual proclivities. In another concerning a solicitor one of the parties was threatening the filing of a complaint with a disciplinary jurisdiction.
Sadly when matters go to Court a ‘no holds barred’ approach is deployed and people’s dirty linen can be aired in the most public of forums. Divorces and alcoholism often affect a professional’s ability to discharge his or her obligations to partners and colleagues. Such human failings can destroy partnerships just like marital break ups often lead to home lending foreclosures. Most people prefer to keep private matters, private. Mediation with the “bolt on” of confidentiality clauses can achieve this outcome; this is more difficult in the case of courts.
It is critical to establish what the remuneration is along with its criteria. There must be clarity on point.
Key Performance Indicators KPIs
Each partner needs kpi`s ie “key performance indicators”. Typical kpi`s address:
- Income generation targets for each partner
- Marketing obligations of each partner
- Quality control and level of excellence expectations for the partnership
- Ethical tenets
- In the case of legal and accounting businesses, billable targets and accountabilities
- Formulas that reward higher individual contribution
Who Owns the Assets?
If the partnership is a collaboration to buy and develop real estate, for instance, then exactitude is required to spell out:
- who owns what shares of the realty?
- What does each party contribute by way of capital input?
- How profits upon sale are to be distributed
- How capital gains are to be shared and in what percentage
- If one party provides the land and the other funds the building costs then how upon sale each party is to be remunerated
- Each party`s role has to be considered and where a tangible contribution is brought to the table it needs to be recognized and rewarded.
If a partner isn’t performing, the agreement should contain a mechanism that affords the non performer notice of failure to achieve a kpi. The agreement should require that the non performer be appraised of the kpi that has not been met and there should be given time to lift his or her game. Failing which the partner can be removed without any repudiatory consequences.
The clause also needs to canvass issues like:
- Final pay out if any
- If the partner owns equity then there should be a formula that is invoked to calculate the worth of the equity
- And if the partner owns any property (real property or otherwise) then the agreement will need to have addressed these subtleties. Just because a partner is a non performer, doesn’t mean that he/she doesn’t have some stake in the business or the good will and the matter of non performance should not be confused with the notion of whether monies or assets are owed to the recalcitrant.
- Often it is the little things that destroy a partnership. I mention the plural because one isolated action of non sinister gravitas will not destroy a partnership, rather it is the aggregation of a number of little things. One has to recognize that humans are often very jealous creatures and if a given individual is perceived to be getting too many non reciprocal benefits then tensions will surely surface.
- Consider budgets for entertainment and travel. If one party’s business development model involves wining and dining then the agreement should traverse this. There are minders, finders and grinders, if partners have teamed up because one doesn’t like to mine but would prefer to grind, then the agreement needs to commit to reflect this. These elements cannot be left unsaid.
- If one partner needs to travel to secure work and his or her preferred medium is business class then that should be spelt out from the outset.
- Resentment in a partnership is toxic and can destroy the fabric of the business, so those whom are intent upon going into partnership with one another should anticipate areas that could give rise to tension, and capture the solution in the agreement before they commit.
Resolution of partnership disputes
If the partnership agreement is well crafted and has intelligently thought through dispute resolution pathways evident in the exit or termination provisions, then the partners will indeed be able to conclude their affairs sensibly with minimal angst.
Absent well crafted exit provisions then partnership terminations like divorces can turn very ugly. Touch wood there will be a mediation clause, if there is a mediator then the mediator should be afforded a great deal of latitude in assisting the partners resolve their disputes. Compromise will be paramount because a poorly crafted partnership agreement does not lend itself to anyone being able to maintain the high ground. Rightly or wrongly if one of the partners has entered into a partnership agreement that is in essence a bad deal, then alas the bad deal will be enforceable.
“When the shark bites stop the bleeding.”
There is no room for sentimentally or the taking of umbrage in partnership disputes, one has to bite the bullet and contain and minimize the collateral damage. Rarely does this translate into a windfall. When partnerships dissolve there will be disruption, inconvenience and distress, the paramount thing is to minimize it and to work towards accord rather than discord.
Some closing thoughts
If there is ever a case for retention of members of my fraternity it is to prepare a partnership agreement. In the case of new partnerships, the team should engage one firm to draft the agreement and the lawyer needs to ask the hard questions, get the answers and ensure that the agreement incorporates conditions that are designed to minimize and resolve disputes. Why? Because there will be differences from time to time and the agreement if well crafted will culminate in reconcilable rather than irreconcilable differences
Don’t neglect the exit clause, partners come and they go. The partnership needs to ensure that the departure of one of the team does not destroy the critical mass and conversely the exiting partner needs to have provisions that enable him, her or it to leave with dignity, equanimity and reputation intact.
Alas if one were to find oneself embroiled in a partnership dispute and the agreement were to prove deficient then for god’s sake get a good lawyer enlisted and stress to that lawyer that s/he is not there to poor petrol on the fire, rather s/he is there to put the damn thing out. Further try to get it mediated.
Finally some salutary advice to partnership entities. Be very careful when you make the decision to terminate the colleague’s tenure. Make sure that you terminate rather than repudiate. Even though there may be very good reasons to end a relationship unless the termination process is carried out carefully and in accordance with the agreement there can be dire consequences. On point is an article that we recently published on the perils of wrongful termination; to access it click here
This article is prepared by Kim LovegroveKim along withJustin Cotton are always at hand to help partnerships or partners out. They have done so in the past and will do so in the future. To find out more about our skill sets on point click here and browse the partnership dispute resolution services of the firm. Finally we also have a mediation division and information regarding the same can be accessed by clicking here