Partnerships – Breach of Duty

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Posted by: | Date: 22 July 2011

I recently was involved in a case where I acted for a partner of a business (90% ownership) who had experienced considerable angst when the other partner (owning a 10% interest) departed the business and took with him approximately 60% of the client base.

This matter highlighted to me, and all parties involved, the quite severe consequences that apply if a partner breaches his/her duties towards the other partner in a business.

The Facts – Partnerships

A brief summary of the facts are as follows:

  1. Partner A (90%) and Partner B (10%) owned a professional services business.
  2. The partnership agreement included a restraint of trade, where Partner B was not allowed to compete with Partner A should he leave the business.
  3. Partner B decided to leave the business and the principal of Partner B resigned as an employee.
  4. At the time of resignation, the partnership was not formally dissolved.
  5. Partner B wrote to a number of existing clients (on partnership B new employer’s letterhead) making a number of misleading statements to entice clients of the partnership to change over to the new employer.
  6. A number of clients signed the document referred to above without knowing that Partner B had actually left the business and was now working for the third party.
  7. Partner A was understandably upset as the business suffered a considerable loss of income and the value of the business deteriorated significantly as a result of the departure of these clients.

The Law – Partnerships

 A summary of the advice given to Partner A is:

  1. Claim against Partner B

    a) Damages for breach of the partnership agreement in the context of the fiduciary relationship between Partner A and Partner B;

    b) Damages for misleading and deceptive conduct under the Trade Practices Act (now the Australian Consumer Law);

  2. Claim against the principal of Partner B

    a) a claim based upon a statutory cause of action as a Director of Partner B, pursuant to section 197 of the Corporations Act;

    b) Damages of breach of the fiduciary duty between the principals conduct in orchestrating the breach of the partnership agreement;

    c) Damages for misleading and deceptive conduct under the Trade Practices Act (now the Australian Consumer Law).

  3. Claim against the third party

    a) Damages because of the third party’s “knowing assistance” to Partner B in orchestrating the breach of partnership agreement; and

    b) Damages for misleading and deceptive conduct under the Trade Practices Act (now the Australian Consumer Law).

Legal Remedies

The legal remedies that Partner A was entitled to included:

a) An injunction against Partner B, the principal of Partner B and the third party to stop them from acting for the clients that had unlawfully been taken from the business;

b) An account of profits for all monies received by Partner B, the principal of Partner B and the third party;

c) Compensation for the loss of commissions that would otherwise have been likely to have been received by Partner A, but for Partners B breach, or alternatively a capitalisation of the value of that loss of commissions.

The matter was settled on a confidential basis, at an early stage, without the necessity to institute Court proceedings.

Lessons Learnt

This matter highlighted the need to:

a) Conduct a thorough due diligence on parties before you enter into a partnership;

b) Have a properly constructed partnership agreement (in this matter we were able to rely upon the terms of the partnership agreement);

c) Be fully aware of your obligations as a partner (and your other partners obligations towards you) in the conduct of your business;

d) Complete very detailed records of your client base and your activities in dealing with clients, as this information was critical in demonstrating Partners A case against Partner B.

Please do not hesitate to contact me if you would like any advice in relation to your obligations as a partner, or setting up your partnership agreement. Partnerships are a great way forward for many businesses however, it must be setup correctly.

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