In my last article about the viability of partnerships, I wrote about the difficulties of managing partnerships. In this article, I will focus more on the legal aspect and how agreements between partners (and shareholders) can help mitigate some of the challenges partners (and shareholders) face when building a business.
When two or more people work together, whether as partners or shareholders of a corporation, they enter into a legal relationship with each other. This reality is regardless of if they sign an agreement or not.
For my last article, I lumped partners with shareholders. In this article, I will be a little more careful about distinguishing the two, because legally speaking, these are two separate concepts governed by two separate acts or laws.
The Partnership Act of Manitoba governs partnerships. A partnership arises when two or more individuals work together with a view of making a profit. They could arise intentionally if the partners agreed they would form a partnership or arise unintentionally when two or more individuals start working together on a project.
For example, if you are a carpenter and work with another carpenter to build a home and share the building's costs and the profit once the home is sold, you are likely partners.
The Corporations Act of Manitoba governs corporations and their shareholders. Corporations are legal entities. You can read more about the advantages and disadvantages of creating a corporation here. So, rather than partnering with someone else to work on projects with a view of making a profit, the "partners" can incorporate a company where they are both shareholders. The newly incorporated company would be the legal entity performing the projects and making the profits. The profits can then either be re-invested in the corporation or distributed to shareholders as dividends.
In partnerships, the partners are still separate entities within the partnership. They must submit their own individual income tax return. So, if a partner is not incorporated, then they are equivalent to a sole proprietor. All the profits become income and must be reported.
However, despite being solely responsible to Revenue Canada, a partner remains liable for anything that happens to or in the partnership. So if your partner does something that attracts liability, you automatically become liable. Partners can create liability because each partner can legally bind the partnership.
Conversely, when two individuals create a corporation, the corporation becomes legally responsible. The directors can bind the corporation (typically, when two shareholders create a company, they name themselves as directors.) As in partnerships where each partner can secure the partnership, each director can bind the corporation. However, the director rarely becomes liable personally. Only the corporation remains liable.
If something drastic occurs where the corporation does not survive (i.e. a lawsuit that leads to bankruptcy), the corporation goes bankrupt. The shareholders do not, and their assets are protected. In contrast, a partner would remain personally liable and risk losing their home and other personal assets.
As I previously stated, agreements can't make partners or shareowners get along. These are blunt instruments of last resort. When two parties can't agree anymore, they pull out the contract or agreement that outlines the remedies available. In that way, they are like insurance policies. You don't need them until something goes wrong.
However, agreements do provide the parties with an opportunity to consider remedies in the event of discord while they are still on good terms. In addition to giving the parties remedies when the relationship falls apart, negotiating an agreement informs the parties beforehand of their future consequences. Suppose you know that you can lose your ownership stake in the business because of an estranged relationship with your business partner. In that case, you will likely work harder to maintain that relationship in the first place.
Both partnership and shareholder agreements share common clauses. A good agreement should address the following issues:
These are general guidelines. The contract itself should be thorough and consider many things, including the possibility that a party may refuse to engage. What do you do when a party does not respond to letters or signs documents? (You can create a power of attorney in the document itself that allows another Party to act on behalf of the negligent one)
So while a written agreement won't undo a bad relationship, it will provide parties with a roadmap while they are still in agreement. That road map will also serve as notice to a party and likely influence their decisions, hopefully motivating everyone to remain on good terms. If that proves impossible, it will pave the road out.
If parties fail to create an agreement, then the common law and the statutes take over, which means that a court must impose a settlement. As previously written about here, litigation takes time and costs money. Few small corporations or partnerships actually survive litigation.
This article is presented for informational purposes only. The content does not constitute legal advice or solicitation and does not create a solicitor-client relationship (this means that I am not your lawyer until we both agree that I am). If you are seeking advice on specific matters, please contact Philippe Richer at 204.925.1900. We cannot consider any unsolicited information sent to the author as solicitor-client privileged (this means confidential).
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