Contractual Aspects of Formation and Composition of Commercial Partnerships

Author:Kaspars Balodis
Position:Associate Professor, University of Latvia, Member of the Study Group on a European Civil Code

1. Introduction - 2. Conclusion of a partnership agreement - 3. The legal nature of a partnership agreement - 4. Important issues of mutual relations of the partners - 5. Implications of a partnership agreement for relations with third parties - 6. Conclusion


Kaspars Balodis

Associate Professor, University of Latvia, Member of the Study Group on a European Civil Code

Contractual Aspects of Formation and Composition of Commercial Partnerships

1. Introduction

According to the principle of freedom of contract, the participants in a joint business undertaking are free to agree on the legal form of company that best suits their needs. One of the possibilities is setting up a commercial partnership. A partnership is a form of business entity known worldwide that enables two or more persons to engage in commercial activity without creating a company that is a legal person. The main feature of a partnership is that the partners are personally liable to the creditors of the partnership. Although nuances of the organisation of commercial partnerships may vary from one European country to another, the two main legal forms are the general partnership and the limited partnership. The main feature of a general partnership is that the liability of the partners to the creditors is not limited. In a limited partnership, there are general partners, who are personally liable without limit, and limited partners, whose liability is limited by the amount of their contribution to the capital of the partnership. In commercial partnerships, as contrasted against capital companies (private limited companies and public limited companies), there are more possibilities to fix the rights and obligations of the partners by contractual means. In private limited and public limited companies, the mutual relations of company members, composition, the powers and the duties of the management, and supervisory institutions are quite strictly regulated by law. The partnership agreement is the main legal tool shaping the structure and composition of a partnership. In a number of European countries - for example, Germany, Latvia, and Estonia - the regulation of commercial partnerships is closely connected with the rules governing civil law partnerships. Whereas commercial partnerships are founded for commercial purposes, civil law partnerships can be created for the attainment of any common goal through united efforts of the partners. Usually, the rules governing civil law partnerships can be found in the civil codes, whereas commercial partnerships are regulated in the commercial codes or other special laws. Unlike commercial partnerships, civil law partnerships cannot be registered in the commercial register. The civil code provisions governing partnership contracts apply also to commercial partnerships, to the extent that the special rules concerning commercial partnerships do not provide otherwise. Partnership agreements establishing commercial partnerships are contracts with features of both contract law and company law. They not only regulate the relationship of the partners but also create legal implications in relation to third parties.

2. Conclusion of a partnership agreement

A partnership agreement establishing a general or limited partnership can be concluded either by a natural person or by an entity possessing legal capacity. That means that not only legal persons but also other commercial partnerships can form a commercial partnership. Civil law partnerships and other entities that do not have legal capacity cannot be parties to a contract creating a commercial partnership. As a general principle, the partnership agreement is form-free and can be concluded even by implied conduct1. For example, an actual joint commercial activity undertaken by partners can qualify as conduct establishing a partnership agreement2. The general civil law rules on forms of legal transactions apply. Special form has to be observed only if the law provides formal requirements for specific obligations - e.g., if immovable property is contributed to the property of the partnership3. In any case, written form is advisable as a tool for evidence. As soon as the agreement is concluded, the partnership comes into existence. These principles regarding the form of a partnership agreement apply also to any subsequent changes in the agreement4. In relation to third parties, however, a partnership exists only from the time it is recorded in the commercial register or, alternatively, from the first entry into commercial transactions before registration5. The partners have broad discretion to choose the contents of the partnership agreement, in particular as regards issues such as decision?making, profit-sharing, and representation6. As far as the mutual relations of the partners are concerned, the principle of freedom of contract applies to the greatest possible extent. With regard to relations to third parties, the contractual freedom of the partners is restricted by law7.

3. The legal nature of a partnership agreement

The basic features of an agreement creating a commercial partnership are identical to those of civil law partnership agreements. Compared with other private law contracts, the partnership agreement is a specific one. On the one hand, a partnership agreement establishes performance duties - for example, an obligation to contribute to the property of the partnership. Thus, a partnership agreement has features of a contract establishing obligations. On the other hand, the agreement is an organisational contract aimed at the formation of an association of persons8. The partnership agreement is a reciprocal contract, though it is not aimed at exchange of performances9. The typical forms of reciprocal contract, such as sales contracts, leases, or employment contracts, entail an exchange of performances to fulfil contractual obligations. The aim of a partnership agreement is a consolidation of performances10. The reciprocity of contractual obligations in a partnership agreement means that any partner can request the other partners to perform in keeping with the agreement - in particular, to contribute to the property of the partnership.

Since there is no mutual exchange of performances under a partnership agreement, no partner, as a general principle, can deny performance on grounds that other partners fail to perform their duties11. According to the predominant view in German legal doctrine, a partner can withhold his performance only if 1) the partnership consists only of two members and the other member does not perform and 2) all other members of the partnership fail to perform12. Wider application of the right to withhold performance would lead to a paralysis of the partnership13. In addition, from the time the partnership comes into existence in relation to third parties, no partner can withdraw from the agreement on grounds that another partner has failed to perform14. In such cases, according to German and Latvian partnership law, only notice of termination or, if good cause exists, a claim for termination of the partnership is possible as regards withdrawal15. Whereas the general rules governing withdrawal from a contract are contained in the law of obligations, the notice of termination and the termination claim are regulated by partnership law. According to section 99 of the Commercial Law of Latvia, notice of termination may be issued by a partner if the partnership was established to act for an indefinite time and the notice is issued not later than six months prior to the end of the accounting year. Any commercial partnership can be dissolved under section 98 of the Commercial Law of Latvia if a member, for good cause, submits a termination claim to a court. 'Good cause' is a general clause whose meaning has to be fleshed out in practice with a certain content by courts and legal doctrine. Section 98, para. 2 of the Commercial Law of Latvia provides a general characterisation for a 'good cause', declaring that good cause shall exist especially when another member of the partnership in bad faith or by allowing gross negligence does not perform significant duties imposed upon him by the partnership agreement or such duties have become impossible to fulfil. A German commercial law commentary lists libel, physical assault, denunciation, criminal charges against one partner by another, fierce enmity, conviction of a partner, lasting illness of a partner, and incompetence of the management as examples...

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