Before signing a partnership agreement: management, profits, exit and disputes

A partners’ dispute does not begin on the day it erupts. It usually begins on the day an agreement was signed that never answered the hard questions. Who manages? Who can sign, and up to what limit? How are profits divided, and when? And what happens if one of them wants out, stops paying, or dies?

Partnerships normally start between people who agree with each other and are optimistic, which is exactly why spelling these things out feels like suspicion. In reality, a good agreement is not written for the period of agreement. It is written for the period of disagreement. If that period never comes, nothing is lost; if it does, there is something to govern it.

What follows are four areas to settle before signing, with the Companies Law as the reference on legal forms and their rules.

The legal form is not an administrative detail

Choosing the legal form of the entity is not a formality to be left to whoever handles the registration. It determines the boundaries of liability, how decisions are taken, and what is required procedurally to amend the structure or to admit or remove an owner.

The questions the choice rests on: what is the activity and how much risk does it carry? Are new partners or an investor expected later? Does the activity need special licences that carry requirements about the form of the entity? How large are the expected obligations towards third parties?

A recurring mistake is choosing the form purely on ease of incorporation, and discovering later that changing it takes procedure, cost and time, or that liability under it runs wider than the partners assumed.

Management and signature

This is the most commonly skipped area. Many agreements settle for a general line — “partner X shall manage the company” — and then the dispute arrives over what managing means.

What should be in writing starts with who actually manages — one partner, several acting jointly, or a manager from outside the partners — and what his financial signature limits are, with a ceiling for sole signature above which a joint signature or written approval is required. Then the decisions that cannot be taken alone: borrowing, granting security over an asset, entering a long-term contract, hiring on exceptional terms, opening a branch. Then how decisions are recorded, which means written, numbered and retained minutes rather than scattered messages in a group chat. Then whether the managing partner is paid: is there a management fee separate from his share of profits, and how much.

A hypothetical: two partners with equal shares; one works in the business full time, the other contributes only capital. Two years in, the working partner asks for a management fee for the period already worked, and the other says his share of profits was the payment for his work. The dispute did not arise from bad faith. It arose from a gap in the agreement that one line would have closed.

Profits, losses and drawings

Dividing profits in proportion to shareholdings is a rule everyone understands. The practical disputes happen in the detail around it:

When is a distribution made: annually after the accounts are approved or in instalments, and what minimum stays in the business to fund operations. What about drawings on account: may a partner draw before distribution, up to what limit, and how is it reconciled at year end. How are losses handled: are the partners required to inject further funds, and what happens if one refuses. And what about later funding: is it a loan from the partner or an increase in his share, and at what valuation.

Unregulated drawings on account are one of the biggest causes of partner disputes, because they start small and acceptable and accumulate until they are a disputed figure with nothing to resolve them against.

Exit and the unexpected

This section is written at a time when nobody imagines needing it, and it is the most useful section when it is needed.

A voluntary exit needs to say how a partner gives notice of wanting out, and whether the others have a right of first refusal and within what period. Valuation needs either a method agreed in advance or an expert appointed through a defined mechanism, because leaving valuation without a mechanism turns an exit into a separate dispute. Payment needs to be specified: a single payment or instalments, and with what security. Death or loss of capacity is settled in advance — do the heirs become partners, or does the share pass to the remaining partners against payment at a valuation. What counts as a material breach is defined, along with what follows from it and whether there is a cure period first. And non-competition is addressed: is the exiting partner restricted, over what scope and period, bearing in mind that a restriction with no limits may not survive.

The dispute-resolution clause is not copied from another contract

The dispute-resolution clause is the last thing read and the first thing needed. Three points deserve attention.

A real mechanism. A clause saying “disputes shall be resolved amicably, failing which through the legal channels” adds nothing. A useful clause sets a defined first step with a deadline, then names the forum.

A valid arbitration clause. If the partners choose arbitration, the Law of Arbitration requires the arbitration agreement to be in writing, failing which it is void, and requires the number of arbitrators to be odd, failing which the arbitration is void. Those are conditions of validity, not drafting niceties.

How arbitrators are appointed, where the arbitration sits and in what language are matters the parties may agree. If they do not, the law fills the gap: the competent court appoints the arbitrator in the cases it specifies, the tribunal determines the seat having regard to the circumstances of the case and the suitability of the place, and the arbitration is conducted in Arabic unless the parties agree or the tribunal decides otherwise. Settling those three in the contract does not cure a void clause, but it stops the dispute from opening with a dispute about procedure.

Two further points are worth noting. An arbitration clause contained in a contract is treated as an agreement independent of the contract’s other terms, so it does not fall with the nullity, rescission or termination of the contract if it is sound in itself — and the Civil Transactions Law says the same, that a dispute-resolution undertaking does not lapse on rescission of the contract unless otherwise agreed. And government entities may not agree to arbitration without the approval of the Prime Minister, unless a specific statutory provision permits it.

Proportionality. Choosing an expensive mechanism for a potentially small disagreement can make litigating minor matters uneconomic in practice.

An existing partnership with a thin agreement

Plenty of partnerships run for years on a brief constitutive document that does no more than the registration required. The question that follows is whether it is too late.

It is not. While the partners still agree, the agreement can be amended and the gaps filled, and whatever has become the practice in fact can be recorded so that it cannot be denied later. Doing that while everyone agrees is easier and cheaper than attempting it after the first dispute, when every new clause is read as a win for the other side.

The review starts with a simple comparison: what does the agreement say, and what actually happens? In many entities it turns out that the registered manager is not the person managing, or that the distribution percentages applied differ from those written down, or that a partner injected funds that were never recorded as either a loan or an increase in his share. Each of those is settled today by a line, and tomorrow by a claim.

Five vague phrases worth rewriting

• “Profits shall be distributed as agreed” — agreed when, and by what majority? Replace with explicit percentages, a mechanism and timing.
• “The first partner shall manage in the company’s best interest” — “best interest” is a matter of interpretation. Replace with a financial ceiling and a list of reserved decisions.
• “A partner may transfer his share with the consent of the partners” — consent by what majority, within what period, and what if it is withheld for no reason?
• “Disputes shall be settled amicably” — with no deadline and no route afterwards, this delays rather than resolves.
• “The partner shall devote his usual efforts” — unmeasurable. If full-time work is meant, write it as hours and a fee.

What to prepare before drafting

• A clear description of the activity and the plan for the coming years.
• What each partner contributes — cash, work or assets — with a valuation for anything that is not cash.
• Who will work full time and who will not, and what is expected of each per week.
• The expected funding sources and who guarantees them.
• Whatever has been agreed verbally and never written down — the most important item on this list.

In short

A good partners’ agreement does not prevent disputes; it gives them a reference point. Most partner disputes that reach a court can be traced to one of four gaps: undefined powers, unregulated drawings, valuation with no mechanism, and exit with no route.

Working through those before signing costs far less than dealing with them once each side is committed to its own reading.