Do you know which type of business entity you’re using?

Setting up a new business is a stressful time and deciding on the correct structure may not be at the top of your list. But, a recent judgment of the High Court serves as a reminder of why getting your business structure right at the outset is critical.

In Malik v Hussain Junior [2020] EWHC 2334 (Ch), the High Court held that a partnership between two people had begun before they signed a formal partnership agreement and before they had begun trading, and that their partnership had continued despite their later incorporation of a limited company to operate their restaurant business.

The Facts

The case concerned a property (the "Stockport property"), which was jointly owned by two people and eventually a company, which the same two people were also shareholders of (the "Stockport company") and which operated a successful Indian restaurant business from the Stockport property.

A simplified timeline is:

• 2000: the claimant (Tariq) and his brother acquired the Stockport property.
• December 2001: Tariq and the defendant (Mahboob) had discussions about renovating the Stockport property to provide for an Indian restaurant.
• May 2002: a joint account was opened in Tariq and Mahboob's names, from which payments were made to fund the refurbishment.
• July 2002: following a series of payments, the Stockport property was transferred into Mahboob and Tariq’s ownership.
• August 2002: the Stockport company was incorporated to operate the restaurant business. However, the Stockport property remained in the names of Tariq and Mahboob.
• April 2006: a partnership deed was entered into.
• 2016: the parties had an "irreversible falling out".

The Arguments

Tariq's claim included that there was a partnership encompassing the Stockport property and the Stockport company. Mahboob's defence asserted that, despite the partnership deed, there was no partnership, and that his and Tariq's legal relationship was limited to being co-shareholders in the Stockport company and co-owners of the Stockport property. In this instance, the distinction was particularly important as there was an additional restaurant business operated through a separate company which Tariq was not a shareholder of, but Tariq was seeking for the partnership to include that business too (this part of the claim failed).

Amongst other points, the court therefore had to resolve whether, prior to the incorporation of the Stockport company, a partnership had arisen and, if so, what effect the incorporation of the Stockport company had.

The Decision

The court held that the discussions and actions taken in early May 2002 to early July 2002 amounted to a partnership. Tariq and Mahboob had agreed to go into business together, to own the Stockport property together and to use it to run the restaurant, and they had opened a joint account in their own names.

The court was "satisfied that they regarded themselves as partners in a general sense in a business venture" and was not concerned that the business wasn't trading as "actual trading is not an essential pre-condition for a partnership to exist".

The court also held that the partnership was not dissolved by the incorporation of the Stockport company. There was no evidence that the partnership relationship was to be brought to an end; rather, the court inferred that the parties intended to continue to own the whole business as partners, but for the company to operate the restaurant business on behalf of the partnership.

The Takeaways

The key points from this case are:

1. Ensure that the structure you are using for your business is the correct one and get it in place early on. See our blog on options here.
2. Document your intention. Contemporaneous records should help reduce time and costs in the event of a falling out. The judge commented that "the parties have now spent a considerable amount of time and money litigating this dispute".
3. Don't assume that setting up a company will necessarily dissolve an existing partnership.
4. If you want to change structure from a partnership to a company be sure to take advice, including about how to transfer to the company any assets (for example, IP, domain names, property, etc.) which have been acquired or registered in the name of an individual on behalf of the partnership; otherwise, problems can arise, including during any later diligence or sales process.
5. Be aware that a formal partnership agreement isn't required for a partnership to exist.

Daniel Bryan is a Senior Associate in the Corporate team.

Disclaimer

This note reflects our opinion and views as of 2 November 2020 and is a general summary of the legal position in England and Wales. It does not constitute legal advice.

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