The break up of a partnership is always a pressured and difficult time. Although it may not be an event which partners want to think about, it is critical that thought is given and agreements reached before the business or relationship breaks down – ie while the partnership is being set up, or when it is functioning well and relationships are strong.
Commonly, well run partnerships will take care to provide how assets are to be divided in the event that a partner leaves. In addition however, it is important to identify how those assets will be valued in those circumstances. This valuation issue was considered in the recent case of Ham v. Ham & another.
The defendants were a married couple who worked as dairy farmers. They owned land, a sizeable dairy herd, machinery and other assets. Their son (the claimant) subsequently joined them in the business and a partnership agreement was drawn up.
The deed entitled any of the partners to serve notice to dissolve the partnership on three months' written notice. In that event, the other partners had the right to buy out the outgoing partner's share of the assets as an alternative to dissolution. However, the deed did not make it clear how the value of those assets was to be assessed.
The claimant gave notice to terminate. A dispute arose as to the basis on which the buy-out was to take place. The judge at first instance determined that, as a matter of interpretation of the deed, the claimant's share was to be determined on the same basis as annual accounts were drawn during the continuation of the partnership, rather than on the basis of an up-to-date market valuation of the partnership assets. The claimant appealed.
The Court of Appeal ruled that there are no presumptions or default rules pointing towards any single basis of valuation of an outgoing partner's share. Instead, it is necessary to take account of any relevant and admissible background in interpreting the partnership deed. In this case, it was important that the deed related to a family partnership. It was also important that the partnership was a dairy farming partnership which, by its nature, was likely to be asset rich but cash poor. The clause in this case was concerned only with the consequences of termination. The basis on which accounts were prepared during the continuance of the partnership was no real indication of how the partners intended to deal with or value the partnership assets once the partnership ended. In addition, in this case the ability to buy out the departing partner's share was designed to be an alternative to winding-up the partnership. If the partnership was instead wound up then all the assets would be sold and the realised profits on such a sale would be shared between the partners according to their share of profits.
On the true construction of the partnership deed, the claimant's share in the partnership property was to be calculated on the basis of what he would have received on a winding up (i.e. at the current market value of the assets).
The Court was critical of poorly drafted partnership agreements and stated that it was to be hoped that in future those preparing partnership agreements would take note of the anxiety, expense and delay caused by imprecise drafting.
Of course, all of the cost of disputing these points could have been saved had the partners taken steps to agreed the basis on which one of the partners could leave before the event.