How to deal with a breach of partnership agreement by a business partner?

Founding a business venture with a partner or a group of people can be an exciting experience, but it can also lead to stressful situations when one or more of your partners fails to adhere to the provisions of the partnership agreement. 

Jonathan Feniak, J.D., M.B.A., General Counsel and Head of Finance at LLC Attorney, with extensive expertise in law and business, emphasizes that any deviation from established contract terms—such as failure to fulfill specified roles, misappropriation of business assets, or failure to stick to the agreed profit and loss sharing agreement,  constitutes a breach of the partnership agreement.

What is typically included in a partnership agreement?

Forming a partnership is, apart from investing efforts and time together, about creating a formal contractual business relationship. Generally, the terms in the partnership agreement are guided by the parties’ preferences and priorities, and ideally, the partnership agreement will be the primary tool for handling breaches of contract.

According to C.L. Mike Schmidt, an attorney from Schmidt & Clark LLP, a partnership agreement typically includes the nature of the business, the capital contribution of each partner, profit and loss distribution, decision-making processes, dispute resolution mechanisms, and procedures for admitting new partners or handling the exit or death of a partner.

At the very minimum, the following elements should be included in a partnership agreement:

• Details of the Partners : name and address of the parties to the agreement

• Type of Partnership: partnership a general partnership or a limited partnership

• Business Description and Purpose: clear description of the business and its purpose must be included

• Contributions: lay out how much each partner whill be contributing financially 

• Division of Profits and Losses: How will the partners split the profits and losses?

• Decision Making: outline the decision making process to be followed by the partners

• Partner Roles: clearly specify the roles and responsibilities of the partners

• Exit Strategy: outline the process to be followed if a partner wishes to leave the partnership and address the the steps involved, and effects of their share and decision making rights.

• New Partner: specific guidelines for admitting new partners

• Dispute Resolution: outline the mechanisms for resolving disputes

What constitutes a breach of a partnership agreement?

A breach of a partnership agreement occurs when one fails to fulfill the duties or obligations as outlined in the agreement.

The breach can stem from a variety of sources, and these are some common reasons:

1. Improper use of company funds

Breaches can arise when a partner uses company funds improperly or unscrupulously. Examples of misusing company funds may include unauthorized personal expenses, extravagant purchases or even embezzlement.

2. Acting outside the scope of authority

When a partner acts outside of their authority without authorization, this can cause business issues. For instance, one gets too excited about a possible business deal and signs up for something without getting the proper permissions as stipulated in the agreement.

3. Disclosing confidential partnership information

Breaches can arise when a party fails to maintain the confidentiality of sensitive business information and discloses information such as financial data, pricing information, future projects, etc.

4. Failing to contribute agreed-upon capital or resources

Most partnership agreements outline the capital contributions required for each partner to fund business operations and growth. Failure to do so deprives the partnership of necessary resources and constitutes a breach.

5. Engaging in activities that directly compete with the partnership business

Sometimes, partners owe fiduciary duties to the partnership. For instance, the duty of loyalty prohibits them from engaging in activities that compete with the partnership’s business interests. Diverting business opportunities away from the partnership for personal gain may constitute a breach.

According to M. Denzell Moton, Esq, founding partner of Moton Legal Group, a breach occurs when a partner fails to adhere to the terms laid out in the agreement. This can range from failing to meet their financial commitments or not fulfilling their management duties, to more severe actions like misuse of partnership assets. For example, if one partner in a business litigation case at our firm unilaterally decided to redirect funds without approval, that would clearly constitute a breach.

Identify and consult a legal professional

The first and foremost step in dealing with a breach of contract is to review the terms, conditions and obligations outlined in the agreement. You should recruit a business attorney with experience handling the type of issues you are encountering, preferably one that is not affiliated with your company, to help you assess the situation. You may want to read this blog post on what questions to ask your attorney before approaching one.

Once you have identified the breach, it is crucial to document it meticulously, which serves as critical evidence if the dispute escalates. Consider recording the following:

• Dates and times of the breach

• Detailed descriptions of the breach

• Any documents or supporting information related to the breach, such as emails or chat messages

What are the options available to you?

Many partnership agreements include an outline of what should be done when a breach arises. Some stipulate that one partner cannot bring a lawsuit against another for losses, while some require mediation or arbitration. Others may stipulate that the partner can seek liquidated damages. In general, you may have one of these options available to you with the help of an attorney, but mostly subject to your partnership agreement.

1. File a lawsuit against the partner for the contract breach

Depending on your situation, and if you are not bound by clauses such as the forced arbitration clause, you may file a lawsuit against the partner expelled from or against a partner staying in the partnership. Although a lawsuit does not represent the best option, you should consider a lawsuit to secure compensation to cover the losses of your partner:

• leaves the partnership early;

• misappropriates your assets; or

• engages in fraud.

2. Seek liquidated damages from the partner

Your agreement may contain a liquidated damages clause which guarantees a set amount of compensation in the event of breach of contract. Still, the court will consider whether the clause is reasonable and applicable under the relevant law before enforcing the clause. To maximize the damages you receive, you will definitely need a knowledgeable and skilled business attorney to assist.

3. Expel the partner from the partnership

Your ability to expel a partner depends on your partnership agreement, and you must dissolve your partnership to expel unless otherwise stipulated in the agreement. In cases of serious breaches, you usually have the right to seek the expulsion of your business partner from the partnership. This means your business partnership will be dissolved and the partners will pursue separate paths. Dissolution of the partnership may be most ideal option if you need to protect your legal rights and financial interests from a major breach.

4. Negotiate a settlement

Another way to resolve the breach is to negotiate and finalize a settlement agreement, which can be done in either an informal or more structured way, such as in mediation. Although you probably need to compromise with your partner to reach a settlement agreement, such a method may help repair business relationship and save costs in litigation. You can always create a binding settlement agreement to protect your rights with the help of legal professionals or experts in your field. Here is a blog post that discusses alternative dispute resolution (ADR).

The above options are not mutually exclusive such that you may, for example, expel the partner from the business and file a lawsuit seeking damages. Discuss these options with your attorneys, provide all relevant information, and ensure the final decisions align with your business goals.

What if you don’t have an agreement with your partner?

We understand that not all business partners draw up official agreements for a partnership, but don’t leave the fate of your partnership to chance - secure your business with one of DocPro's  tailored partnership agreements.

Developed by experienced attorneys qualified in various common law jurisdictions, DocPro templates for partnership agreements follow industry best practices and prevent costly disputes down the road. 

If you want to create one, why don’t you read this blog post detailing the features of a partnership and the relevant templates to use?

Final thoughts

A well-drafted and comprehensive partnership agreement is the backbone of any successful business partnership. While dealing with the stress of your partner’s breach, remember to stay focused on your core business goals and make decisions that align with those objectives. The key is to act quickly, seek legal guidance, and explore all possible options.

FAQs

1. Should I communicate directly with the partner in breach of partnership agreement?

 You must ensure all interactions are professional and meticulously record them since verbal agreements are hard to prove in court. These discussions could be relevant in the future, and may strengthen your case if there is a written record of discussions and correspondences.

2. What are the things I should not do?

You should, first of all, not let any of your impulsive reactions affect your actions and long-term business interests. Second, you should avoid neglecting the breach since you may lose your right to pursue your legal remedies. Doing nothing may make some sense only if the breach is very minor and immaterial such that you can deal with it informally. Third, you should never retaliate by breaching your contractual obligations as this will diminish your position in any legal proceedings.

David J. Greiner, Esq., an expert in business law, real estate, contracts, buy-sells, and corporate formation and governance, advises against abruptly terminating partnerships or making unsubstantiated accusations. Such actions can escalate conflicts and complicate efforts toward resolution.

3. Can the breach of a partnership agreement be resolved without legal action?

It can often be resolved  through alternative dispute resolution methods or other means such as negotiation and damages. In fact, lawsuits should always be an absolute last resort.

Mark Pierce, a seasoned businessman, attorney, and Founder & CEO of Wyoming Trust & LLC Attorney, emphasizes that whether the breach can be resolved without legal action often depends on the nature of the breach, willingness of the parties involved to negotiate, and how well the partnership agreement was drafted in the first place.

4. How can I protect myself from the breach of a partnership agreement in the future?

You should ensure your partnership agreement is comprehensive, clearly outlining the expectations for all partners and especially the dispute resolution mechanisms. Regular communication can also help prevent breaches. Consider this blog post before starting a partnership.