However, things do not always run smoothly in partnerships. As a 27 year old senior manager, I was delighted to be offered partnership in a four partner firm of chartered accountants. I gave little thought to the legal ramifications of what was being offered and accepted the partnership on the terms of the agreement that was presented to me.

At the time of leaving there were several issues to be resolved. When I discussed this with my lawyers I discovered that I had fallen into a very common situation where the issues needing resolution were likely to prove more expensive to pursue than could economically be justified.

In general the smaller the partnership, the greater the negative impact of a partnership dispute on the business and the more embittered the dispute becomes.

This is probably because larger partnerships are more likely to have agreed procedures to deal with circumstances giving rise to disputes. Also, the greater the number of individuals in partnership the less personal a dispute should become and the more likely it is that a sensible solution can be found by negotiation.

Why disputes arise

The reasons that partners fall out can usually be summarised into: an actual or perceived inequality in input to the business linked to partners being unhappy with profit sharing arrangements; one or more partners drawing too much cash from the business.

This is often linked to a downturn in business profitability or cash generation and partners being reliant upon particular drawings levels to maintain their lifestyle; external factors such as marriage breakdown, illness or financial problems; and the impact of one or more partners wishing to leave the business and the arrangements surrounding this departure.

The partnership agreement

A well-structured partnership agreement is the best way to prepare for any issues that might arise between partners.

It enables the partners to agree procedures to be applied if certain potentially contentious situations arise.

In the event of any dispute, the partnership agreement enables the route to resolution to be set out. This will encompass the voting requirements for different categories of partnership decision and will usually specify how any residual grievances should be dealt with.

There is however, no requirement for partners to have a formal written agreement and if no formal partnership agreement exists then in the event of a partnership dispute, the Partnership Act 1890 is the main legislation that would be relevant.

New partners need to understand that PA 1890 prescribes: an equal sharing of profits; and that any difference arising as to ordinary matters may be decided by a majority of the partners, but no change may be made in the nature of the partnership business or another partner admitted without the agreement of all partners.

The "input" problem

Equality is still the most common form of profit sharing arrangement in the smaller partnership. This can work very successfully when all partners trust each other and value their respective inputs into the business.

The partners need to consider how differing input might be dealt with. Unfortunately there is no easy way to define how profits should be shared between partners in different circumstances. In most cases the solution will be a combination of reward based on financial contribution and recognition of management and business development input.

The practical problem for the smaller partnership is that nonfinancial input is difficult to measure. A common solution is for the first tranche of profit to be shared on an equal basis with a second tranche of profit shared based on relative financial contribution.

A number of benefits are achieved by the partners agreeing in advance, by stating in a partnership agreement, how profit share should be dealt with: it encourages the partners to accept that, during the life of any partnership, it is quite usual for partners to contribute to the business in different ways and with differing levels of respective input; it forces the prospective partners to sit down together and discuss a difficult issue. If they cannot agree how varying input should be rewarded, then this highlights that they should reconsider whether partnership is the correct route for them; if a profit share method is agreed by all at the outset, then this minimises the likelihood of future dispute and this initial outline framework for sharing profits can in any case be revisited in future years if necessary.

The "outflow" problem

Another prime cause of partnership dispute is one or more partners drawing out more from the business than their profit share permits or than their fellow partners.

A number of steps can be taken, within the partnership agreement or in the general management of the partnership, to minimise the likelihood of a dispute being triggered by excess drawings.

Set conservative drawings levels for the partners that are linked to profitability. These can use a formula based on anticipated profit levels less taxation and a contingency reserve just in case things go wrong.

Ensure that the partners have regular financial management information so that any possibility of excess drawings can be identified and corrected at the earliest opportunity.

Ensure that the partnership retains sufficient funds to meet partners' business taxation liabilities and that these can be paid out of retention of historic profits as opposed to an anticipation of future profits, which may not materialise.

Incorporate interest on partnership capital within the profit sharing arrangements so the partners with the greater financial interest in the business are appropriately rewarded and overdrawn partners are penalised.

When it all goes wrong

However good the partnership agreement and management style, disputes can still arise.

Ultimately a partnership dispute can only be resolved by a combination of negotiation, mediation, legal action or dissolution.

However, when it seems inevitable that a dispute will escalate, what can be done to aid a speedy resolution?

Nip it in the bud If matters cannot be resolved amongst the partners, seek professional help at an early stage. Alternative Dispute Resolution is the collective term for the ways that parties can settle civil disputes, with the help of an independent third party and without the need for a formal court hearing.

More information on this can be found on the website of the Department for Constitutional Affairs at www.dca.gov.uk/civil/adr/ Keep talking and negotiating and take full advantage of mediation and ADR.

If dissolution is unavoidable ensure there is appropriate accountancy advice as regards taxation issues and other complexities such as valuation and assignment of ongoing contracts.