In a continuing series, Peter Garry looks at partners' liabilities for a firm's debts, and the importance of clarifying who does and does not classify as a 'partner'

One of the most frequent issues in partnership litigation is which of the 'partners' is liable for a firm's debts or other liabilities.

Determining this is not always as straightforward as many assume, as illustrated by the recent case of Sangster v Biddulph [2005] PNLR 33, [2005] EWHC 658.

The first question that may arise is whether or not an individual has been a partner at all, as opposed to merely having been held out as a partner. The importance of determining who are the true partners is that a true partner will be liable to a creditor whether or not the creditor even knew of that partner's existence.

In Sangster, the two solicitors holding themselves out as 'partners' had entered into a document described on its front page as a 'partnership agreement', one of the provisions of which was 'the principal has invited the partner and the partner has agreed to be a partner with the principal in the practice'. Coming to that agreement for the first time, one might be excused for reaching the initial conclusion that these two individuals were partners. However, further review of the partnership agreement reveals that the 'partnership' was created expressly for the purpose of enabling the firm concerned to satisfy the requirements of a mortgage-lender client. The 'partner' did not share in the profits or losses of the practice but simply took a commission on the gross fees generated by the mortgage-lender client, irrespective of profit.

Before dealing with the outcome of Sangster, it is instructive to review the general law on what are the identifying features of a true partner.

The labelling of individuals as 'partner', or as different types of 'partner' - equity, full, fixed share, variable share, salaried - often has limited legal significance. Rather, one has to look at the true nature of the relationship. The following hallmarks of partnership are often cited in support of, or (by virtue of their absence) when contesting, partnership status:

  • Sharing profits and losses;

  • Not an employee;

  • A say in management;

  • A proprietary interest in the property of the firm, giving the partner a right to share in the distribution of assets on winding- up of the firm, under section 39 of the Partnership Act 1890. An indicator of such status is often the appearance in the books and records and/or accounts of the firm of a capital account in favour of the partner concerned.

  • None of these is necessarily conclusive.

    In the well-known case of Stekel v Ellice [1973] 1 WLR 191, a sole practitioner accountant, E, entered into an agreement with S that S should join the practice as a 'salaried partner' on a fixed salary, with a view to becoming a 'full partner' later. E was to contribute all of the capital and bear any losses, and S was to have no rights in the capital or profits of the practice. S was nonetheless found to be a partner, because of the following provisions in the agreement between them:

  • The parties had expressly recited their intention to enter into partnership (but compare what happened in Sangster);

  • In certain events, either could give notice to the other of dissolution of the partnership;

  • In the event of E's death, S would be entitled to the entire practice, though obliged to pay E's capital account out to E's executors;

  • An arbitration clause contained an express power for the arbitrator to dissolve the practice.

  • Section 2 of the 1890 Act provides a number of 'rules' to which 'regard shall be had' when 'determining whether a partnership does or does not exist', thus:

  • Common ownership of property does not of itself create a partnership, whether or not accompanied by sharing of profits (section 2(1));

  • The sharing of gross returns does not of itself create a partnership (section 2(2));

  • The receipt by a person of a share of the profits of a business is prima facie evidence that he is a partner in the business, but noting that a contract for remuneration of a 'servant or agent' by a share of profits does not of itself give rise to a partnership (section 2(3)).

  • While this statutory guidance is a starting point, it is far from conclusive, and every case will turn on its own facts.

    Apparently prompted principally by section 2(2), the claimant in Sangster conceded before trial that there was no true partnership. This excused the 'partner' from liability to the claimant, unless he had been held out to and relied on by the creditor as a partner.

    If true partnership cannot be established, one next turns to holding out, under section 14(1) of the 1890 Act and/or pursuant to common law estoppel by representation. It is not enough that someone has consented to be listed on the firm's letterhead as a partner, or has otherwise been, and has consented to being, held out as a partner. The creditor must establish reliance on the 'partner' at the time of giving credit to or instructing the practice, or before any negligent act relied upon occurs.

    In Sangster, it was common ground that there had been holding out and that 'in order to establish reliance... the claimant must establish ... that on a balance of probabilities... the holding out... had a material influence on [the] decision to proceed with the... transaction'.

    The court found that the creditor had relied sufficiently on the holding out. It accepted the claimant's evidence that she had considered that 'where there are two partners in a firm, if one does something wrong, the other might rein in the wrongdoer'. She conceded that she had not focused on the names of the partners listed on the firm's notepaper as she had 'already been told that the firm had two partners'.

    Though other factors also influenced the claimant's choice of firm, it was enough that the fact the firm had two partners was 'a factor' in her decision. There was no suggestion that this one factor was the principal reason for selecting the firm, though from the evidence it appears to have been a significant factor, having been mentioned as a benefit by the person who recommended the firm to her.

    Sangster should be compared with Nationwide Building Society v Lewis [1998] Ch 482, in which the claimant's 'reliance on a two-man firm' argument failed, because there was no evidence that anyone in the building society had noted from the solicitors' letterhead that the defendant's name appeared as a partner. In Nationwide, the court drew attention to the absence of 'some personal characteristic of [the salaried partner] that would bring him to the attention of the plaintiff'. That said, from Sangster it is clear that it is enough to have considered and relied merely on the number of partners, as opposed to the particular identity, skills, experience or creditworthiness of any one or more of them.

    Peter Garry is head of the partnerships and professional practices group at south-east law firm Cripps Harries Hall