The benefits and pitfalls of partnership status

PARTNER RIGHTS as an employee have been reinforced following a high court case which claimed they have employment rights including the right not to be unfairly dismissed.

But it raises the issue that there are advantages and disadvantages in adopting a partnership structure for a business.

Being a partnership, the business owners share the profits, the liabilities and the decision making, which can be a huge advantage, especially where the partners have different skills. A partnership is generally easier to form, manage and run. They are less strictly regulated than companies, in terms of the laws governing the formation and because the partners have the only say in the way the business is run (without interference by shareholders) they are far more flexible in terms of management, as long as all the partners can agree.

The main drawback of partnerships is unlimited liability, where each partner shares the liability and financial risks. This can be countered by the formation of a limited liability partnership, which benefits from the advantages granted to limited companies, while still taking advantage of the flexibility of the partnership model.

If a partnership model is adopted, there will often be both partners and employees working in the company. However, the term "partner" can denote a whole spectrum. They could be salaried, fixed share, equity, LLP member or an employee. However, establishing whether someone described as a partner is an employee or a partner is important for a number of reasons.

It can determine the individual's rights and duties: employees benefit from statutory employment protection including unfair dismissal rights; and tax issues where the status of an individual will affect their treatment of tax.

A decision handed down by the Court of Appeal on 1 February provides some assistance. In Tiffin v Lester Aldridge LLP the Employment Appeal Tribunal held that a fixed share member of an LLP who made a contribution to capital, enjoyed limited voting rights and a small share of profits was a member, not an employee.

The fact that his share of profits and his decision making powers were limited did not point away from him being a member. However, although profit share will tend to point away from employment status, it may not be a sufficient factor taken on its own.

These cases illustrate that, if the intention is that an individual should be a partner, the starting point should be a clearly defined partnership or membership agreement. This will not only help to determine the nature of the relationship, but can regulate rights and duties between the partners.

Legislation governing partnerships provides little assistance in determining partnership status but case law suggests a variety of factors which need to be considered. The factors which will tend to point to partnership status include: entitlement to a share of residual profits and a requirement to contribute equally to any losses the business sustains; the right to have access to, inspect and copy any of the partnership books; and right to be an authorised signatory for the business, for example when dealing with the partnership's bank account, as well as the right to hire and fire the firm's employees.

None of these factors are determinative but the presence of one or more will tend to suggest partnership status. However, applying these factors to particular situations can be difficult.

Tim Marshall is a partner at DLA Piper