Running a Business? You Should Have an Estate Plan: Part II – Partnership

Published on: May 2020 | What's Trending

Two pieces of puzzles drawn with a marker, one has partner written on it and the other ship to read partnership

Part II – Partnership

You’ve built a business plan for success. Now, it’s time to build an estate plan for succession.

This is the second article in a series focusing on estate planning for business owners, based on the type of business structure an owner might choose. Our first article looked at estate planning considerations for sole proprietors.

Today, we are focusing on estate planning for individuals in a partnership: two or more individuals carrying on business together with an intention to profit (where the business is not incorporated).

There are different ways to structure a partnership. In its simplest form, all the partners own all the assets, take on all the liabilities, and share in all the profits, equally. Different partnership structures may have specific issues that we won’t get into here. But, the general points below will apply to any form of partnership.

Operating a business as a partnership means you need to consider more than just your family, friends and charitable interests when you make your estate plan. You also need to consider your business partners.

Do you have a partnership agreement?

 In terms of succession planning for partnerships, the most important question is – Do you have a partnership agreement?

In Ontario, the Partnerships Act, R.S.O. 1990, c. P.5 (the “Act”) creates a set of default rules that apply to all partnerships. Many of these default rules can be modified by an agreement between the partners, often called a “partnership agreement”. A partnership agreement should be in writing and signed by all the partners. Sometimes, an agreement can be implied – but this can be very expensive because it means you are asking a court to decide on your rights instead of negotiating them yourself. You also lose an important element of control. Getting it in writing up front is the safer way.

Without a partnership agreement, implied or in writing, you are subject to the default rules that apply under the Act, both when you run the business as partners and after you die. This can have unintended consequences both for the business and your estate.

For example, under the Act, a partnership is automatically dissolved between all partners if one partner dies (even if there are multiple surviving partners). This is a problem if you want your heirs to continue in the business. It could also be a problem for your remaining business partners if you all intended the business to keep running after you die. Only a partnership agreement can avoid this rule and provide for the partnership to continue .

The Act also creates default rules for distributing business property and profits. Most importantly, the default is to divide profits and property equally among partners, both while the business is running and when a partner dies. This is a problem if you put in more work or capital and expected a larger share of the profits or property. It’s also a problem if your partner(s) expected a larger share and take your estate to court to get it! Again, only a partnership agreement can avoid this rule and provide for the distribution you and your business partners expect.

A partnership agreement can modify many other default rules. This means it is important to make sure the agreement truly reflects your business operations and expectations, both while you are running the business and after your death.

Do you have a Will?

Once you have the partnership agreement in place, your estate plans need to reflect and work together with the partnership agreement. So, the next important question is – Do you have a Will?

By making a Will, you will ensure that your Executor will step in your shoes to act on your behalf and you give your Executor instructions on your interest in the partnership.

For example, if the partnership agreement allows your executors to designate your replacement to the partnership, then your Will should provide them with guidance on this if you have someone in mind.

On the other hand, if the partnership agreement provides that your interest will be bought out at fair market value, you need to take into account the incoming cash (and tax liability) when deciding how to divide your estate.

As we discussed in part one of this series, if you die without a Will in Ontario, no one is legally authorized to act on your behalf and deal with your interest in the partnership until someone is appointed as “Estate Trustee Without a Will” by our court. Therefore, without a proper plan in place, your family would go through this costly, lengthy and complicated court proceeding.

Building a business with partners means added challenges of managing different perspectives. But, as the saying goes, two heads can be better than one. The same is true for your estate plan: working with a lawyer can help you understand how your partnership impacts your estate and help to create a plan for your loved ones.