The Importance of a Well-Drafted Partnership Agreement

Putting a business plan into writing in a legally sound and carefully thought-out agreement is the best and most effective method to ensure control over how various events will play out. In particular, it can be especially important to plan for the death of the key stakeholders in a business. Legally speaking, if a plan is not put into place during a person’s lifetime, this can become a cause for litigation among the surviving parties.

In business, this means drafting an agreement that sets out what will be done with the assets and the business in the event of the death of an owner or partner. The significance of a lack of a plan was recently highlighted in a decision by the Ontario Court of Appeal called Canadian Home Publishers Inc. v. Parker (2019).

Partnership Agreements Drafted, But not Executed

Canadian Home Publishers (CHP) was formed in 1985 as a limited partnership in order to acquire a magazine known as Canadian House & Home. The entity consisted of two parties: Canadian Home Publishers Inc. (CHPI), as general partner, and an individual, DR, as limited partner. CHPI was owned entirely by DR’s wife at the time, LR. DR was to provide all of the capital investment for the venture, and the business was structured to be as beneficial as possible to DR from a tax perspective. Both parties agreed to share the profits of the business equally.

DR made an initial capital investment of $1.8 million. The magazine ultimately became quite profitable, at one point being valued in excess of $50 million.

Six years after starting the venture, the couple divorced, but remained business partners. While partnership agreements had been discussed and drafted, no agreement was ever executed, and no plans were made respecting how to handle the death of one of the partners. After the divorce, the parties entered into litigation over various aspects of the partnership and the business, but the litigation ultimately fell into abeyance.

Residual Assets Ordered to be Split Equally

When DR passed away in 2012, the litigation resumed, when the respondents, the estate trustees of DR’s estate, obtained an order to do so. At that point, the appellant brought an application seeking a declaration of the following:

  • That the limited partnership had been dissolved upon DR’s death; and
  • That DR’s estate’s interest was limited to payments in respect of DR’s share of profits to the date of his death, and repayment of his remaining capital contribution to the business.

The appellant essentially sought a declaration that DR’s estate had no entitlement to an interest in the residual value of CHP once the limited partnership had dissolved upon DR’s death. In the initial proceedings, the application judge found that once DR had passed away, CHP no longer had a limited partner, and so the limited partnership had dissolved. As a result, CHP was required to wind up the business and distribute the assets of the business pursuant to s. 24 of the Limited Partnerships Act (the “LPA”), which reads as follows:

In settling accounts after the dissolution of a limited partnership, the liabilities of the limited partnership to creditors, except to limited partners on account of their contributions and to general partners, shall be paid first, and then, unless the partnership agreement or a subsequent agreement provides otherwise, shall be paid in the following order:

    • To limited partners in respect of their share of the profits and other compensation by way of income on account of their contributions.

    • To limited partners in respect of their contributions.

    • To general partners other than for capital and profits.

    • To general partners in respect of profits.

    • To general partners in respect of capital. 

With respect to the residual assets of the business, the application judge found that the LPA was silent on this issue and turned to the Partnerships Act (the “PA”) to fill in the gap. Under s. 44(3), the PA holds that the “ultimate residue, if any, is to be divided among the partners in the proportion in which profits are divisible”. Given that, the application judge ordered that the residual assets of CHP be divided equally between the appellant and the respondent, which would be consistent with the parties’ agreement to share in the profits equally. The appellant appealed this aspect of the decision.

ONCA Holds That Residual Assets Remain With General Partners

The Ontario Court of Appeal (ONCA) found that the applications judge had erred in using the provisions contained in the PA to fill in a perceived gap in the LPA with respect to residual assets. On plain reading, the LPA provides that limited partners have very strict rights and obligations, which do not include the right to residual assets upon dissolution of the partnership. The ONCA concluded that had the drafters of the LPA intended to grant such a right to a limited partner, they would have done so. Given that they did not, the clear intention was to reserve the right to residual assets for the general partner(s). This interpretation was consistent with the broad rights granted to general partners under the LPA.

Takeaways for Business Owners

In the absence of an agreement, courts will turn to existing legislation to manage disputes in a business, particularly in the event of the death of a key stakeholder. In order to ensure that the wishes of the parties are carried out effectively in these circumstances, having an agreement in place is essential. Not only will an agreement dictate the manner in which assets will be distributed, but it will also help the surviving parties avoid unnecessary litigation. Speaking with an experienced lawyer and having a business plan and/or partnership agreement drawn up is key for anyone looking to start a venture, and for existing businesses.

The skilled business lawyers at GLG LLP in Toronto regularly assist organizations of all sizes and structures with a variety of issues, including configuration and structure of the venture as well as drafting comprehensive and carefully considered business agreements. Call 416-272-7557 or complete the online form to arrange a consultation with one of our lawyers today.