People who want to pool their resources, knowledge, or skills can form a general partnership (or, more simply, a partnership). A general partnership is a type of business organization that comes into existence when two or more people carry on business together with the intent to make a profit. A partnership is established automatically by law when individuals meet the necessary criteria and start working together. While no formalities are required to create this partnership, you may need to register the business name and obtain a business license.

Imagine that you and your friend Sarah decide to open a bakery. Sarah will handle the baking, you will manage the marketing and sales, and you both agree to split the profits. Even if your bakery doesn’t turn a profit, as long as your goal was to make money, you may have formed a partnership.

This guide will explore the essential characteristics, benefits, and risks of general partnerships in Canada. By understanding the basics of this business structure, you can make informed decisions and build a solid foundation for a successful and legally sound partnership. Keep reading to learn how to navigate the complexities of general partnerships and maximize the potential of your collaborative venture.

Understanding the implications of a general partnership

Similar to sole proprietors, partners carry on business on their own behalf. Although the business can do some things in the name of the partnership the partnership is not legally separate from the partners. This has several important consequences:

1. Employment status: A partner cannot usually be employed by the partnership.
   
2. Profit distribution: All benefits of the partnership business accrue directly to the partners. In your bakery, all profits would be shared between you and Sarah, rather than being paid out as salaries.
   
3. Liability: All partners, even those who did not consent to a particular obligation, are personally liable for all the obligations of the business, including torts committed by a partner or an employee in the course of the partnership’s business. For example, if an employee of your bakery causes an accident while delivering goods, both you and Sarah could be held personally liable for any resulting damages.

Just like a sole proprietor, partners have unlimited personal liability. If the bakery incurs debt or another obligation, each partner is liable to the full extent of the obligation. This means that all of your personal assets—not just those you committed to the business—may be seized to satisfy a partnership obligation. For instance, if your bakery takes out a loan and is unable to repay it, both your personal and Sarah’s assets could be used to cover the debt.

Understanding these implications is very important for anyone entering a general partnership. It highlights the importance of having thorough understanding of each partner’s responsibilities and liabilities.

Partnership statutes and partnership agreements

In Ontario, Canada’s most populous province, partnerships are governed by the Partnerships Act (Ontario). Except for Quebec, the legislation in other provinces is generally similar, although Ontario is used as an example.

The Partnerships Act (Ontario) allows for the creation of general partnerships, where all partners are jointly and severally liable for the liabilities of the business. It also permits the formation of limited liability partnerships, a structure reserved for regulated professions in Canada, such as law and accounting.

Partners typically use a partnership agreement to supplement the rules governing their relationship. These agreements provide clarity on roles, responsibilities, profit sharing, and dispute resolution. Legal issues related to the partnership are generally resolved based on both the statute and the partnership agreement, ensuring that the partners have a clear framework to manage their business.

Forming a partnership

A partnership is formed when two or more individuals engage in a business together with the intention of making a profit. However, sometimes it’s not immediately clear if a partnership exists under this definition. Various factors need to be evaluated, with the most important being the sharing of profits. Sharing profits typically indicates that the partners are jointly managing the business and its expenses. When you and your partner share in the profits, you have a vested interest in the overall success and management of the business, making it likely that a court would recognize the relationship as a partnership.

However, simply sharing profits does not automatically establish a partnership. There are several scenarios where profits might be shared without forming a partnership. For instance, if a loan from a creditor is repaid using the profits of the borrower’s business, this does not create a partnership. Similarly, an employee whose salary fluctuates based on the employer’s profits, as seen in profit-sharing arrangements, is not a partner. Another example is when the buyer of a business agrees to pay the seller a portion of future profits as part of the purchase price; this arrangement does not constitute a partnership either.

There are several key factors that can be used to determine whether a partnership exists, which include:

1. Enduring business relationship: An ongoing business relationship usually signifies a partnership. For example, if you and a colleague consistently work together in managing a consultancy firm, this enduring relationship would indicate a partnership. In contrast, if two individuals collaborate on a single freelance project, this one-time cooperation is unlikely to form a partnership.
   
2. Active vs. passive participation: Passive investors, like those who merely co-own a retail space and collect rental income, are less likely to be seen as partners. Conversely, if the co-owners actively manage the retail operations and share the profits, their active participation may suggest a partnership.
   
3. Representation: If someone publicly represents themselves as a partner or allows others to do so, they are likely to be considered a partner. For instance, if an individual’s name is prominently featured in a company’s branding, they might be recognized as a partner.

In Sarah’s case, a court will determine whether a partnership exists or if someone is considered a partner by evaluating several factors, including:

• Sharing profits: If both you and Sarah share the profits from your bakery, this may suggest a partnership.
• Sharing responsibility for losses: If you and Sarah both agree to cover any debts or losses incurred by the bakery, it may indicate a partnership.
• Jointly owning property or contributing assets: If both of you have invested money or property into the bakery, this may be a sign of a partnership.
• Participating in management: If both you and Sarah have signing authority for contracts and bank accounts, and you both access business information, this may point to a partnership.
• Representation: If Sarah’s name is included in the bakery’s branding or you both publicly present yourselves as partners, this may support the existence of a partnership.

Understanding liability and risk in general partnerships

Provincial partnership statutes outline when a partnership is liable for contracts and torts. Essentially, each partner acts as an agent of the partnership in the regular course of business, which means that any partner can create liabilities for the partnership.

For example, if you and Sarah formed a bakery partnership and Sarah purchased supplies for the bakery, the obligation to pay for those supplies would bind the partnership. However, an exception occurs if a partner did not have the authority to act in a certain way (perhaps due to a restriction in the partnership agreement), and the other party to the transaction either knew about this lack of authority or was unaware they were dealing with a partner.

In cases where this exception does not apply, all partners share the risk of the partnership being held accountable for contracts entered into by any one partner, regardless of mutual consent. Additionally, partners are liable for torts, such as negligence, committed by their fellow partners in the normal course of partnership business.

Mitigating liability risks as a partner

It’s important for business professionals to understand whether they are entering into a partnership, as partners carry unlimited personal liability for the partnership obligations. This includes liability for unauthorized actions and torts committed by other partners that can bind the firm. Entrepreneurs might accept these risks if they can be managed or if the potential benefits, such as profit sharing or tax deductions for partnership losses, outweigh them. However, others, such as lenders, typically seek to avoid these risks due to the potentially severe financial consequences of being deemed a partner.

To manage these risks effectively, it’s important to carefully assess any proposed business relationship to determine if it constitutes a partnership. Here are some practical dos and don’ts:

Do:

1. Ensure that any contract governing the relationship explicitly states that it is not a partnership.
2. Consider restructuring the business organization to avoid forming a partnership.
3. Negotiate for adequate compensation for any residual risk of being considered a partner.

Don’t:

1. Enter into the relationship without consulting a business lawyer for legal advice.
2. Assume that informal agreements or verbal understandings are sufficient to avoid forming a partnership.
3. Overlook the importance of documenting all agreements and understandings in writing to provide clarity and legal protection.

Final thoughts

Understanding the principles of general partnerships is important for any business professional considering this type of business structure. From managing liability risks to defining the nature of the partnership through agreements, being informed helps ensure that the partnership is both legally sound and beneficial for all parties involved. By carefully evaluating potential partnerships and taking appropriate precautions, you can build a strong foundation for a successful and collaborative business venture.