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Why and How to Draft a Partnership Agreement in China

The biggest mistake made by partnerships is not having a well drafted partnership agreement. Although China law does not require a partnership to have a written agreement, a well written partnership agreement is strongly recommended because: (1) the default partnership rules typically do not mirror the partners' intent; (2) a clearly written partnership agreement will set forth the essential terms and outline each partners rights and responsibilities, and (3) should a dispute arise between the partners, the partnership agreement will help to resolve a dispute that otherwise might cost tens of thousands of dollars to litigate.

China Law When There Is No Written Partnership Agreement.

When a partnership is formed without a written agreement, the rules set forth under General Principles of the Civil Law of the People's Republic of China(GPC) apply. Pursuant to GPC, absent a formal written agreement to the contrary, all partners are considered to be equal partners. Thus if you intended to have a 60-40 split, too bad. Under GPC the default is 50-50 - each partner owns an equal interest in the partnership, has an equal right to operate and manage the partnership business, is entitled to an equal share of the profits, and is 100% responsible for any and all debts and obligations incurred by the partnership business (even when one of the partners didn't know about the debt or disagreed about incurring it. Unless there is a written agreement that specifies otherwise, GPC provides that disputes are settled by a majority vote of the partners and changes to the partnership agreement must be by unanimous vote of the partners. If there are only two partners, and the partners don't agree, under GPC the partners would be forced into litigation to resolve their dispute. If this is not the agreement you want to have with your partners, it is especially important to have a well written partnership agreement.

Under GPC, the partners can alter some of the default rules by executing a written partnership agreement. In a well written partnership agreement, the partners can set forth who has the right to manage the partnership business, how the partners will share profits, how the partners will cover partnership losses or the need for additional capital, the responsibilities of each of the partners (who will do what), and how the partnership will dissolve. Unfortunately, GPC does not permit the partners to limit the personal liability of one or more of the partners for partnership debts and obligations. To acquire the personal liability "shield" will require the parties to form either a China corporation or limited liability company (LLC). Oftentimes, an attorney will provide in a partnership agreement that if the partnership reaches a particular milestone that the partners will dissolve the partnership and either incorporate the partnership business or form an LLC.

 

Equal Share in the Profits and Losses.

When a general partnership is formed either without a written partnership agreement, or with a general partnership agreement that is silent on the sharing of profits, GPC provides that each partner is entitled to an equal share of the profits.

Equal Authority To Manage.

When a partnership is formed without a written agreement, or with a general partnership agreement that is silent on the issue of management, GPC provides that each partner has an equal right to manage and operate the partnership business. GPC further provides that disputes that arise regarding the ordinary partnership business are decided by a majority vote of the partners (with each partner having one vote). A well drafted partnership agreement can limit, and/or divide, the responsibility for management of the partnership business and can structure the power to make decisions among the partners in infinite ways. A well drafted partnership agreement should also provide a reasonable means to resolve a deadlock, which may include an outside advisor rendering a decision, an arbitrator, or for serious matters the triggering of a buy-out clause so that one partner may resolve the deadlock by purchasing the interest of another partner without resorting to costly litigation.

Equal Right to Unilaterally Bind Partnership.

Under GPC each partner not only has an equal right to manage the business of the partnership, but also the ability to unilaterally bind the partnership. Any partner can obligate the partnership (and in turn the other partners) and each partner is personally liable for the decisions and acts of all the other partners. In other words, the act of one partner, with or without the consent of the other partner, will bind the other partners and the partnership itself. Because a partnership does not provide "personal limited liability protection," general partners are personally liable, jointly and severally, for partnership debts, obligations, and liabilities. Consequently, the debts and liabilities of the partnership are the debts and liabilities of each partner. Needless to say, this is a major source of litigation among partners and why it is critical to have a well drafted partnership agreement.

GPC provides for a limited amount of protection by allowing the general partnership to file a Statement of Partnership Authority with the China government authorities. Unfortunately, this only provides limited protections, primarily with respect to real estate, and absolutely no protection if all of the partners have the authority to make decisions. Since each general partner can be held liable to third parties for actions taken in the course of the partnership business, it is dangerous to enter into a partnership without carefully defining the relationship and considering the consequences.

Issues That Should Be Addressed In Every General Partnership Agreement.

At a very minimum, a written partnership agreement should set forth the purpose of the partnership business and exactly what is expected of each partner in terms of time, duties, and financial contributions. For example, will one partner be putting up the financial capital while the other partner puts in the work? If so, I guarantee there will be times when the person doing all of the work feels they are entitled to a bigger piece of the pie and times when the financial partner feels the other partner isn't working hard enough. For this reason, it is extremely important that the partners have an understanding from the beginning as to what is expected from each partner. A written partnership agreement should also specify whether additional compensation will be paid to a partner who performs work at some particular time (e.g. after so many years, after the financial partner has recouped his or her investment, if additional work is performed, etc..) A written partnership agreement should also specify with great detail when and how the profits of the partnership will be split, and how losses will be divided and paid. Other terms that should be included in any written partnership agreement include:

1.Term of the partnership.
2.Purpose of the partnership and what outside competitive activities the partners may engage in.
3.Initial capital contributions of the partners (including money, services, and property).
4.Subsequent capital contributions. If the partnership needs additional capital, will the partners be obligated to make additional capital contributions?
5.How the partnership profits and losses will be allocated among the partners, and when.
6.How the partnership will be managed, including who will make the day-to-day decisions, who will be responsible for what duties, and what acts will require majority approval or unanimous consent.
7.How much time each partner is expected to devote to the partnership business.
8.Whether new partners can be added, and if so how.
9.Under what circumstances a +partner can be expelled.
10.How a partner can withdraw.
11.Which partner(s) will have signature authority on the bank accounts.
12.A means to resolve a deadlock or conflict.
13.A provision providing for the dissolution of the partnership and formation of a China corporation or LLC if the partnership business reaches some milestone.

In addition to, or as part of, a written partnership agreement, the partners should also execute a buy-sell agreement to address the issue of the transferability of their partnership interest. Absent an agreement to the contrary, a partner may freely transfer his or her partnership interest to another person. In addition, absent an agreement to the contrary, the death, incapacity, bankruptcy, resignation or expulsion of any partner may automatically dissolve the partnership. To provide continuity, a buy-sell agreement can provide effective buy out provisions to address various situations.

Whatever form your partnership takes, it is crucial that you have a written partnership agreement. This is true even if your partner is your best friend. While you do not want to go overboard, the more detailed your partnership agreement, the better off you will be in the long run.

Although I typically prefer the corporation as a conduit for business, and in some limited circumstances the LLC, I have extensive experience in forming general partnerships and in preparing general partnership agreements. In fact, a general partnership agreement can be a useful tool for setting forth an agreement for a particular undertaking, task or goal.

 
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