Say two friends in Brampton start a small auto detailing business. No lawyer, no paperwork. One puts in $30,000 for equipment and the unit deposit. The other works six days a week. They split what is left each month and everything goes smoothly until the business gets its first real test: a big client dispute, an unexpected tax bill, or one friend’s decision to move away.
Now the questions start. Does the investor get the $30,000 back before profits are split? Is the working partner owed a wage? Can one of them leave and take the customer list? Can the other bring a brother in? If you have nothing in writing, a statute written in the language of an earlier century will answer many of those questions, and its answers may not match what either of them thought they agreed to.
This article explains the default rules under Ontario law and what a written partnership agreement can do. It is general information and not legal advice about any particular partnership.
You Might Already Be Partners
Under Ontario’s Partnerships Act, a partnership is the relationship between persons carrying on a business in common with a view to profit. No filing or formal agreement is required to create it. Courts look at what the parties actually did, and a share of profits can be evidence of partnership, although the Act’s rules on this have some nuance and receiving a share of profits does not automatically decide the issue.
That has two consequences. You could be someone’s partner without having meant to be. You could also be held responsible for debts you did not know about, simply because of how you conducted the business together. People who help a relative with a venture and take a cut of profits sometimes get an unpleasant surprise this way.
If the partnership operates under a name other than the partners’ own, it must be registered under the Business Names Act. Registration is a separate step from having an agreement, and doing one does not achieve the other.
What Happens Without an Agreement
Section 24 of the Partnerships Act sets out default rules that apply unless the partners have agreed otherwise, expressly or by implication. Some of these often surprise people:
- All partners share equally in capital and profits and contribute equally to losses, regardless of how much money or work each put in.
- No partner is entitled to pay for working in the business.
- Every partner may take part in management.
- No new partner can join without everyone’s consent.
- Ordinary matters may be decided by majority, but changing the nature of the business requires all partners to agree.
- Partnership books must be kept at the place of business, and each partner may inspect and copy them.
Other parts of the Act are just as striking. Section 25 says a majority cannot expel a partner unless an express agreement gives them that power. Under section 26, where no fixed term has been agreed upon, any partner can end the partnership at any time on notice to the others. And unless the partners agree otherwise, the death or insolvency of one partner dissolves the partnership as regards all of them under section 33.
Think of the detailing business. On a default basis, the investor who put in $30,000 and the partner who put in the labour would share profits equally, and the working partner would receive no wage. If one of them gives notice, the partnership could end, and a viable business may have to be wound up. An agreement can avoid each of those outcomes.
The Liability Problem
Before looking at terms, understand the risk that motivates them. Each partner is an agent of the firm and the other partners for the purpose of the business, so when one partner does something in the usual course of the firm’s business, it generally binds everyone. Every partner is jointly liable for the firm’s debts and obligations incurred while they are a partner, and partners can also be liable for wrongful acts committed in the ordinary course of business.
An agreement among partners cannot remove this exposure to outsiders. A supplier or injured customer is not bound by your private arrangement. What the agreement can do is limit what partners may do without consent, and give you a right to be reimbursed by a partner who breaches it. That right, of course, is only as good as your partner’s ability to pay. Insurance and, for some ventures, a corporation may offer stronger protection. Our page on business formation and organization outlines the other structures you could consider.
Terms Every Agreement Should Address
The most useful partnership agreements are written with the real business in mind. Here are the matters they should cover.
Contributions
State who is bringing what: money, equipment, client relationships, a lease, skills, or labour. Assign a value where possible. Say whether capital contributions earn interest and whether they must be repaid before profits are divided. Also address future needs. If the firm needs another $20,000 next spring, who has to provide it, and what happens if someone cannot?
Profit, Pay, and Drawings
Set a percentage for sharing profits and losses, and do not assume it has to match the capital contributions. Partners who work more may get a set draw or a larger share. Spell out when money can be taken out, how much should stay in the business as a reserve for taxes and slow months, and who keeps the books. Because partners generally report their share of income personally, each person needs to set aside money for tax. Have your accountant review these provisions.
Authority and Decision-Making
Give each partner a clear role. Then set limits: for example, no partner may sign a contract over a certain amount, borrow money, hire or fire staff, give a guarantee, or use firm assets without the other’s written approval. This does not bind an outsider who has no notice of it, but it clarifies what is permitted among you and gives you a remedy if the rule is broken. Also arrange the bank account accordingly, perhaps with two signatures for larger cheques.
Time and Outside Activities
Do partners need to work full-time? Can a partner run another business on the side? The Act requires partners to account for benefits derived from firm transactions or firm property, and for profits from a competing business carried on without the others’ consent. Written rules are clearer, and they avoid arguments over what counts as “competing.”
Adding or Removing a Partner
If you want the ability to bring in a new partner on less than unanimous consent, or to remove a partner for specified reasons such as fraud, insolvency, or prolonged absence, you need to write that in. Remember the default: without an express power, a majority cannot expel anyone.
Leaving: Retirement, Death, and Disability
This section may be the most important. Provide that the partnership will continue when a partner leaves, rather than dissolving, and set a process for the departing partner’s interest to be valued and paid. Consider:
- How much notice is needed to leave
- How the interest is valued (formula, agreed value, or independent valuator)
- Whether payment comes in a lump sum or over time, and with what security
- What happens to clients, phone numbers, and the business name
- Whether life or disability insurance will fund a buyout
- Who deals with an estate
A departing partner also needs to take care of their own liability. Retiring does not, on its own, release you from firm debts incurred before you left. The Act provides that people who deal with a firm after a change can treat apparent members of the old firm as still being members until they have notice of the change. So notify suppliers, customers, and lenders in writing, and update the business name registration. A release or indemnity from continuing partners can also help.
Competition After Leaving
A clause can restrict a departing partner’s competition or solicitation of clients. Ontario’s statutory ban on non-compete agreements concerns employers and employees, so it does not usually govern a true partner. These clauses still have to be reasonable under general legal principles, as to time, area, and activity, and an overly broad one risks being unenforceable.
Dissolution
Decide how the firm will wind down if it comes to that, including selling assets, paying creditors, returning capital, and distributing what remains. Section 44 sets default rules for settling accounts, subject to your agreement. Say who has authority to handle the winding up and how the name and records will be treated.
Dispute Resolution
A clause requiring negotiation and then mediation or arbitration before anyone goes to court can keep a disagreement private and limit costs. Decide who chooses the mediator and how costs are split. In a family business especially, keeping a dispute out of a public court file can be a significant benefit.
When Things Have Already Started to Go Wrong
If you are reading this because a partnership is already tense, here are some practical steps.
Secure the records. Partners have a statutory right to inspect the books, and every partner must give true accounts and full information to the others. Ask for what you need in writing, and keep your own copies of statements and tax filings.
Do not empty the account or lock out your partner without advice. Taking matters into your own hands can expose you to a claim, and it could damage the business’s value for both of you.
Watch what you say in writing. Angry messages frequently end up as exhibits. Stick to facts and practical proposals.
Be careful about the people you deal with. Until outsiders have notice of a change, they may be entitled to treat you as still responsible for the firm’s dealings, so a quiet departure can be risky.
Note the deadlines. Claims between partners and against outsiders are generally subject to limitation periods, often two years from when the claim was discovered, though the analysis can be complicated. If a court application becomes necessary, the Partnerships Act allows a partner to apply for dissolution on certain grounds, such as where a partner’s conduct is prejudicial to the business, where the business can be carried on only at a loss, or where a court thinks dissolution is just and equitable. A lawyer’s advice about business disputes can help you choose between negotiating and going to court.
Would a Corporation Be Better?
A partnership agreement is a good tool, but it does not change the basic risk that partners are personally exposed to the firm’s liabilities. If the business has employees, a storefront, large contracts, or significant debt, compare it with incorporating and having a shareholder agreement. Limited liability partnerships are available in Ontario only for practising certain regulated professions, so they are not an option for most ventures in Brampton. Your accountant can help you compare the tax results.
Getting It Done
Set aside an evening with your partner and go through the questions above, even before you see a lawyer. Write down what you each assume. You will probably find a few places where you did not actually agree, and those are the conversations most worth having while things are good.
Then have the agreement drafted properly, with each partner having a chance to get independent advice. The firm’s corporate law services include this type of work. A partnership built on friendship or family stands a better chance of surviving hard times if both sides already know how those times will be handled.