Disputes between partners where one party exceeds authority

Many businesses that are run as partnerships work on the basis that all partners work together towards a common goal. Much of the running of such a business relies on a degree of trust between the partners; that they are acting together to make the business run smoothly to achieve its objectives. If this transpires not to be the case, and one partner oversteps the mark and exceeds their authority, this can be very challenging to deal with on a legal and personal level between the partners. It also affects a third party’s relationship with the partnership.

While there are legal remedies available, these must be exercised with care. It is important to balance the resolution of any conflict with the need to try to ensure all parties can work together going forward, and that external parties are correctly dealt with. Sometimes this is just not possible, but if it is then it is essential that the partnership suffers as little as possible to ensure it can move forward effectively.

In this blog, we look at what happens when one partner exceeds their authority; what this can mean for the business and third parties; and how can this be addressed to ensure as little disruption as possible.

Different types of standard partnership

There are various types of partnership. These can include a partnership similar to a limited company, called a limited liability partnership. The more common entity, and the partnership we concentrate on most here, is a standard partnership. This can occur, and can be implied, where two or more people carry on business together with a view to profit.

How might a partner exceed their authority?

The most common way a partner might exceed their authority is by binding the partnership to a financial obligation that they do not have agreement of the partners to make. For example, it is agreed that partners can only sign contracts for services up to a financial limit of £5,000, but one partner signs a £20,000 contract with a supplier.

How does this affect the partners and partnership?

If the partnership has limited liability, and is therefore a legal entity in its own right, the partners will be shielded from personal financial liability. However, the partners of a general partnership will be jointly and severally liable to any third party that entered a contract in good faith with a person who acts as a partner. This will usually be the case as long as the partner seemed to be acting in the ordinary course of the partnership’s business, even if they were acting outside the authority that had been agreed between the partners.

Under the Partnership Act 1890, which is the law governing general partnerships, each partner acts as an agent for the firm. From an external point of view, their acts can bind the other partners, even if they exceed the internally agreed levels of authority between the partners. 

How can this affect external parties?

A third party dealing with a business can infer that the partner has the authority to enter into an agreement with them on behalf of the partnership, as long as it appears to be carrying on business in the usual way. This will be the case unless the third party knew, or ought to have known, that the partner was acting outside of their authority.

Any specific restriction on a partner's power that is imposed by the partners would only be relevant if the third party knew of the restriction.

If it transpires that the third party did have this knowledge, then the partnership is not bound to pay that third party and the partner who exceeded their authority is likely to be personally liable to the third party instead.

Taking the above example, if a partner at a firm signs a £20,000 contract with a supplier and that supplier reasonably believed that the partner had authority and was unaware of the internal limit; the partnership will have to pay the debt.  However, if the supplier knew that the partners had a limit of only £5,000; the firm will not have to pay it, and the partner may be personally liable.

What remedies do the partners have against a partner who has exceeded their authority?

If the partnership must pay the debts incurred by the partner who has exceeded their authority, the partnership may be able to claim an indemnity from that partner to cover the partnership’s losses.

This will depend on how the partnership is governed. Often a firm will have a bespoke partnership agreement, which may set out what is to happen when this type of situation arises. This is likely to contain a dispute resolution clause to resolve any disputes.

If there is no Partnership Agreement, then the partners have to use the general rules under the Partnership Act 1890. Under this, a partner exceeding their authority is likely to be seen as breaching the general duty of partners to act in good faith to their fellow partners and the partnership.  Breach of this is likely to be considered a breach of contract, and the partners can take action for this breach of contract by suing that partner to make financial recovery of the damage caused.

It may also be a specific breach of the terms of a partnership agreement, if there is one.

Of course, much of the outcome will depend on whether the partner can pay, and whether they will agree to pay. The first step is to attempt to resolve the issue through negotiation with that partner.

If this is not productive, then a dispute resolution clause under a partnership agreement may require the parties to seek a resolution through an alternative dispute resolution method before taking any court action, for example mediation or arbitration. Even without a partnership agreement, the parties can agree to use one of these alternative dispute resolution methods, and this is actively encouraged by the courts as an alternative to litigation.

However, if these steps fail, a claim can be brought by the partnership in court against the partner for damages to recover any losses. In order to do this, it is important to gather as much evidence as possible regarding the actions taken by the partner, and that they were aware of the limit on their authority. This will be easier if the limit is documented in a partnership agreement, but it may be documented elsewhere, such as in email correspondence.

It will also be necessary to evidence the damage that was caused by that partner. For example, that the partnership had to honour a contract it did not wish to enter into.

If the breach is very severe, a partnership agreement may have a clause allowing for a partner to be expelled. There is no right to expel under the Partnership Act. The only option to remove a partner in these circumstances is for the partnership to dissolve in its current form, and then it may be re-formed without a specific partner. If the relationship between the partners has severely broken down due to this partner exceeding their authority, this may be the only option without an expulsion clause in a partnership agreement.

How we can help

A partner who exceeds their authority is likely to bind the partnership, and this can have serious financial repercussions for the partnership. If you believe a partner has bound your partnership and exceeded their authority, then it is important that this is dealt with as soon as possible, so as to ensure the third party is dealt with appropriately, and the issue is resolved between the partners. Our specialist solicitors will work with you to ensure this process is quick and efficient for you.

For further information and assistance, please contact a legal adviser in our dispute resolution team on 01904 624185.

This article is for general information only and does not constitute legal or professional advice. Please note that the law may have changed since this article was published.