When a partner leaves and how a partnership exit works

Partnerships are relationships as much as business structures, so the law does not treat a partner leaving as an event that only affects that person. When a partner retires, dies or is removed, the partnership itself is dissolved by default, and the business that carries on afterwards is, in the eyes of the law, a new partnership. Whether an exit is smooth or costly depends on three things: what the partnership agreement says, how the departure happens, and how quickly the registrations are sorted out.

This article explains how a partnership exit works in Australia: what triggers a dissolution, the difference between a full dissolution and a technical dissolution, what the departing partner remains liable for, and the paperwork that protects the partners on both sides.

Who is involved when a partner leaves

In any exit there are several parties whose interests pull in different directions:

• The departing partner: wants to be paid out for their share, released from future liabilities, and free to move on without tripping over confidentiality or restraint obligations.
• The continuing partners: want the business to keep trading without interruption, with the same ABN, contracts, customers and employees.
• Creditors and customers: have dealt with the partnership as it was, and the law protects their position when its composition changes.
• The ATO and the Australian Business Register: must be told about the change, and their view of whether a new partnership has been created determines whether the business needs a new ABN and tax file number.
• A court: becomes involved if the exit is contested, for example where one partner applies to have the partnership dissolved on grounds of misconduct or breakdown.

The tension between the first two groups is the engine of most exit disputes. The departing partner wants a clean break; the continuing partners want continuity. The law's default position favours neither of them, which is why the outcome usually turns on documents and timing.

The trigger: notice under the Partnership Act

Every state and territory has its own Partnership Act, and the provisions are broadly similar. In New South Wales the relevant law is the Partnership Act 1892 (NSW) (the Act), which defines a partnership as the relation between persons carrying on a business in common with a view of profit.

The starting point is that a partnership is a personal relationship, and a partner who wants out does not need anyone's permission. If the partnership has no fixed term, any partner may end it at any time by giving notice of that intention to all the other partners. No reason needs to be given. The notice takes effect either from the date stated in it or, if no date is stated, from the date it is communicated to the other partners. Where the partnership was originally created by deed, the notice must be signed by the partner giving it.

A fixed-term partnership works differently: it dissolves when the term expires, or when the single adventure or undertaking it was formed for comes to an end. Partners who want a longer runway can agree in advance how exits will be handled, but absent that agreement, the statutory defaults apply.

The source article's suggestion that legislation "usually requires a written notice" is close but not quite right. The Act requires notice, not necessarily writing, although a signed notice is required where the partnership itself was constituted by deed, and in practice a written notice is always the safer course because it creates a clear record of the date on which the dissolution took effect.

Dissolution and technical dissolution: two different outcomes

Here is the point most owners miss. Under the default rules, when the composition of a partnership changes, the old partnership is dissolved and a new partnership comes into being. The ATO takes the same view for tax and registration purposes: if a partner retires or dies, or a new partner is admitted, the partnership is dissolved and a new partnership is formed.

But the ATO recognises an important exception. Where the change amounts to a technical dissolution only, the business can continue as a reconstituted partnership without a new tax file number, ABN or GST registration. A technical dissolution occurs where the continuing partners, and any new partners, take over the assets and liabilities of the partnership and the business continues without any apparent break. The ATO will treat the changed partnership as a reconstituted continuing entity where:

• it is a general law partnership
• at least one partner is common to the partnership before and after the change
• the partnership agreement includes an express or implied continuity clause
• there is no break in the continuity of the business, meaning the assets stay with the continuing partnership and the nature of the business, the customer base and the business name do not change
• there is no period where there is only one partner.

The continuity clause is the mechanical heart of this arrangement. It is the provision in a partnership agreement that says the partnership does not automatically end when a partner leaves and that the remaining partners can carry on the business. In a two-person partnership, a continuity clause can even allow the business to survive a partner's death, with the interest passing to the executor, trustee or beneficiary of the deceased partner's estate.

If the changes in composition amount to more than a technical dissolution, the partnership must be wound up. The partners follow the procedure in the agreement or the legislation, settle the accounts, deal with the ABN and other registrations, and usually record the agreed terms in a deed of dissolution.

Exits the partners did not choose

Not every exit starts with a notice. The Act dissolves a partnership automatically in other situations, although each of these defaults is subject to any agreement between the partners:

• Death or bankruptcy: Every partnership is dissolved as regards all the partners by the death or bankruptcy of any partner. This is why trading and professional partnerships routinely include a continuity clause; without one, a single death can end the business.
• Expulsion: No majority of partners can expel a partner unless a power to do so has been conferred by express agreement between the partners. An expulsion clause must be drafted into the agreement from the start; it cannot be invented at the moment of dispute.
• Court-ordered dissolution: A partner can apply to the court for a dissolution order on grounds that include permanent incapacity, conduct calculated to prejudicially affect the carrying on of the business, wilful or persistent breach of the partnership agreement, a business that can only be carried on at a loss, and any circumstances the court considers just and equitable.

The same defaults illustrate why the "subject to any agreement" qualifier matters so much. A well-drafted agreement converts a forced exit into a managed one, by saying what happens on death or incapacity rather than leaving the business to the mercy of the statutory rules.

What the departing partner is still liable for

The exit does not clean the slate automatically. A partner who retires does not, by retirement alone, cease to be liable for partnership debts and obligations incurred before the retirement. An outgoing partner is discharged from existing liabilities only by an agreement to that effect between the partner, the members of the newly constituted firm and the creditors. In practice the exit agreement records the division of responsibility, and the parties may notify major creditors or seek their consent where the amounts are material.

The business side cuts the other way. A person who deals with a firm after a change in its constitution is entitled to treat all apparent members of the old firm as still being members until that person has notice of the change. A departing partner who wants to stop being treated as a partner of the business must ensure the change is publicised. In New South Wales, an advertisement in the Gazette and in newspapers is treated as notice to people who had no prior dealings with the firm. In practice, the exit documents usually include a mechanism for notifying suppliers, customers and the register.

There is also the money side. Subject to any agreement, the amount due from the continuing partners to the outgoing partner in respect of their share is a debt that accrues at the date of the dissolution or death. The departing partner is a creditor of the business from that moment, and the timing, valuation and security of that payment are matters the exit agreement needs to settle.

The paperwork: exit agreement and deed of dissolution

A well-drafted exit agreement converts a messy personal event into a set of agreed terms. The issues it typically addresses include:

• The payout: how the departing partner's share is valued and paid, including the treatment of work in progress, goodwill, debts owed to or by the partnership, and any adjustment for assets held in the departing partner's name.
• Intellectual property: assignment to the continuing partners of any IP held in the departing partner's name, and continued use of the business name.
• Confidentiality: obligations that survive the exit, covering customer lists, pricing and know-how.
• Restraints: a non-compete or non-solicitation clause. A restraint is only enforceable if it is reasonable in scope and duration and protects a legitimate business interest, so these clauses need to be drafted with the actual business in mind rather than copied from a template.
• Releases and indemnities: mutual releases, and indemnities for liabilities that may attach to one side after the exit, such as pre-exit debts that the outgoing partner remains liable for under the Act.

Where the partnership is being wound up rather than reconstituted, a deed of dissolution records the agreed terms of the wind-up: how assets are distributed, how debts are paid and who signs the final documents.

Where a lawyer comes in

The cheapest time to involve a lawyer is before the exit, when the partnership agreement is being drafted or reviewed. A continuity clause, a valuation mechanism for a departing partner's share, an expulsion power and a sensible restraint regime are all far easier to agree while the partners are still getting along. During an exit, a lawyer's role is to draft the exit agreement and any deed of dissolution, check the ATO treatment of the change, and manage the dispute if the partners cannot agree, including a court application where the grounds for dissolution are in issue. In a contested exit, the costs of an unmanaged departure, in lost customers, disputed debts and management time, usually far exceed the cost of advice.

The moment notice is given

One moment decides most of this. When a partner gives notice, the partnership is dissolved as from that communication unless the agreement says otherwise, and the ATO treats the business as a new partnership unless a continuity clause and prompt notification keep it alive. The exit documents can be drafted afterwards; what cannot be fixed retrospectively is the default position created at the moment of notice. If you are a partner, the practical questions are whether your agreement contains a continuity clause and a payout mechanism, and whether the ATO was told within 28 days of any change in the partnership's composition. If the answer to any of those is no, that is the point where advice pays for itself.