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You are here: BAILII >> Databases >> Scottish Law Commission >> Scottish Law Commission (Reports) >> Partnership Law [2003] SLC 192(11) (Report) (November 2003) URL: http://www.bailii.org/scot/other/SLC/Report/2003/192(11).html Cite as: [2003] SLC 192(11) (Report) |
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PART XI
PARTNERS' DUTIES
Introduction11.1 In this Part we discuss the duties which partners undertake to each other and, in Scotland, to the partnership. We address both fiduciary duties and the standard of care and skill owed by a partner to the other partners and the partnership. We also deal with the duty of a partner to make information about the partnership business and affairs available to his partners. In formulating policy, we consider three principal questions. Those questions are, first, what duties does a partner undertake, secondly, to what extent should legislation specify the duties and, thirdly, to whom should the duties be owed.
11.2 We also discuss the case for the introduction of a duty of disclosure by and to a prospective incoming partner.
Existing law
The duty of good faith11.3 Partners stand in a fiduciary relationship with each other. Fiduciary duties are imposed so that a person:
11.4 Partners need to trust each other in order to engage in a business for their joint benefit. Before the 1890 Act, the courts recognised the central importance of the fiduciary relationship in partnership:… who has had trust or confidence reposed in him by another does not abuse that trust or confidence either for his own benefit or to the detriment of that other relying upon him.[1]
11.5 Notwithstanding that recognition, the 1890 Act does not contain a general statement of the duty of partners to act in good faith. Rather, the Act contains certain rules which are examples of obligations arising out of the particular fiduciary relationship which partnership involves.[3] In particular, section 28 of the 1890 Act imposes on a partner the duty to render to another partner (or his legal representatives) true accounts and full information affecting the partnership. Section 29 requires a partner to account to the partnership for any private benefit which he derives at the expense of the partnership. This duty subsists after the dissolution of the partnership until the winding up is completed.[4] Section 30 requires a partner who carries on a competing business without the consent of his partners to account to the partnership for the profits which he makes from that business.If fiduciary relation means anything I cannot conceive a stronger case of fiduciary relation than that which exists between partners. Their mutual confidence is the life blood of the concern. It is because they trust one another that they are partners in the first instance; it is because they continue to trust each other that the business goes on.[2]
The duty of care and skill11.6 The 1890 Act contains no statement of the duty of care which a partner owes to the partnership. There is uncertainty in both jurisdictions as to the standard of care which is imposed on a partner.
11.7 Historically, in English law a partner's duty to the partnership was to act without "culpable" negligence.[5] In the older authorities the nature and extent of the duty owed by one partner to another was not closely explored, and various expressions are found.[6] There are few reported cases of partners attempting to sue each other in negligence. More recently, Woolf J referred to the duty of a partner to act "without culpable negligence" but he also stated that the partner was "required not to act below the standards of a reasonable businessman in the situation in which he found himself".[7] The latter formulation suggests an objective standard of care. Similarly, in the New Zealand case of Gallagher v Schulz[8] the court required a property valuer who entered into partnership with a passive investor to develop the latter's property, to attain an objective reasonable standard of skill and care. Williamson J held that the property valuer should show the skill and care which would be expected from a prudent valuer and experienced property developer.
11.8 In Scots law the Institutional writers and some cases suggest that a partner is expected to show in relation to the partnership "that diligence which he would show in his own affairs".[9] However, in Ross Harper & Murphy v Banks[10] the Lord Ordinary (Hamilton) rejected this subjective standard. Instead, he maintained that there should be an objective standard of reasonable care between partners and that that standard should be qualified by reference to the way in which the particular partnership carries on its business.[11] The case concerned the liability of a partner to indemnify his partners for loss incurred by the partnership in meeting the excess on a professional indemnity policy in relation to damages paid to a third party for professional negligence. Since the publication of the Joint Consultation Paper this case came before the Inner House on a reclaiming motion where the pursuers did not insist in their claim.[12]
11.9 Another case, Lane v Bushby,[13] a decision of the New South Wales Supreme Court, has been reported since the Joint Consultation Paper was published. That case also concerned the liability of a partner to indemnify his partners for loss incurred in paying damages to a third party for the partner's professional negligence. Dunford J founded on a statutory provision which is substantially the same as section 24(2) of the 1890 Act,[14] requiring a partnership to indemnify a partner in respect of personal liabilities incurred in the ordinary and proper conduct of the business. He held that an implied contractual duty to indemnify his partners in respect of their liability to a third party caused by the partner's negligence would contradict this provision. The provision, referring as it did to ordinary and proper conduct, did not apply where there was fraud, illegality, wilful default or culpable or gross negligence, but it covered ordinary negligence in the course of business. He therefore held that there was no implied term requiring a partner to indemnify his partners for loss caused by his negligence. Referring to Thomas v Atherton,[15] he held that it required wilful misconduct or gross or culpable negligence before the partner at fault was liable. While there is scope for differing views as to whether the statutory provision excludes claims in negligence between partners, it is clear that Dunford J considered that the normal standard of reasonable care did not apply in a question between partners but that a greater degree of culpability was required to give rise to liability. He thus had a radically different view of the policy of the law in this field from that of Lord Hamilton in Ross Harper & Murphy v Banks.[16]
11.10 There thus remains considerable uncertainty as to the circumstances in which partners owe a duty of care to their partners and the partnership and as to the standard of skill and care which the law imposes in the absence of an express contractual statement.
Other fiduciary duties11.11 Because mutual trust is an important aspect of the partnership relationship, partners owe each other fiduciary duties. The obligation to render true accounts and full information is a duty owed by each partner to the other partners.[17] The duty to account for profit and the duty not to compete with the partnership are expressed as duties owed to the partnership.[18] In English law such duties would be owed to the aggregate of partners while in Scotland the duties owed to a partnership would be duties owed to the entity.
No duty to devote full time and attention11.12 There is no duty in the 1890 Act or at common law for a partner to devote his full-time attention to partnership business or, indeed, a reasonable amount of his time for that purpose.[19] The law leaves it to the partners to agree their respective contributions of time and effort. Partnership agreements often oblige partners to devote their full time and attention to the partnership.
No court power to relieve from liability11.13 Unlike company directors and trustees,[20] partners who face claims arising from breach of duty cannot apply to the court for relief on the ground that they have acted honestly and reasonably.
Our provisional proposals
Duty of good faith11.14 In the Joint Consultation Paper we provisionally proposed that there should continue to be a duty of good faith[21] in partnership relations and that it should be set out in a Partnership Act.[22] In the alternative we asked whether there should be a provision that the obligation of good faith applies in specific circumstances such as the expulsion of a partner or the dissolution of the partnership.
11.15 Having regard to the problems which can occur between partners when a partnership breaks up and the partners wish to divide the business connection, we asked whether the court should be empowered to relieve partners from liability for breach of duty where they have acted honestly and reasonably.[23] We also asked whether such power should be available in all circumstances or only on the dissolution of the partnership.[24]
Duty of skill and care11.16 In view of the uncertainty as to the standard of skill and care required of partners, we proposed that there should be a statutory statement of a partner's duty of care. We provisionally proposed that it should be provided that, in the absence of agreement to the contrary, partners are expected to act with such care and skill as can reasonably be expected of those with the general knowledge, skill and experience that the partners have or purport to have.[25]
11.17 We recognised that another option was to adopt the rule that partners must be as diligent in partnership affairs as they would be in their own affairs. We considered that the rationale for the more objective test of a company director's duty of care, which we recommended in our report on directors' duties,[26] does not extend to partnerships. The essence of partnership is the personal relationship between the partners. A partner should take care in selecting a person to be a co-partner and cannot expect more skills of co-partners than they actually possess. On the other hand we suggested that an objective standard of care would be more in keeping with the tendency of case law in both English law and Scots law in recent years.
11.18 We therefore asked consultees if they preferred a subjective standard or an objective standard which required a partner to act with such care and skill as would be exercised by a reasonable person having both (i) the knowledge and experience that may reasonably be expected of a person in the same position as the partner; and (ii) the knowledge and experience which the partner has.[27]
Duty to devote full-time attention11.19 We discussed whether there should be a default rule that a partner should devote full time and attention, or any other specified time and attention, to the partnership. While partnership agreements often oblige partners to devote their full time and attention to the partnership, we suggested that this was a matter for express agreement rather than a default rule. Partners may play different roles within a partnership; a particular partner may provide capital, a prominent name or goodwill to a partnership business without being expected to devote as much time to the business as other partners. A default rule requiring a partner to devote reasonable time and attention would not assist as it would lack precision and would invite litigation. We therefore provisionally proposed that there should not be a default rule imposing a duty to devote a specified amount of time and attention to the partnership.
Court power to relieve from liability11.20 As our proposals sought to restrict the circumstances in which a partnership was dissolved and as we saw the division of a partnership's business connection on dissolution as the most likely circumstance in which a claim to be relieved of an honest and reasonable breach of fiduciary duty might arise, we did not propose any reform. We merely asked consultees whether the court should be empowered to relieve partners from liability for breach of duty where they have acted honestly and reasonably.
Persons to whom duties are owed11.21 The introduction of separate legal personality raises the issue - to whom are the duties owed? Another question is – who may enforce any duties which partners may owe to the partnership? The latter question is not dependent on separate personality but may arise already in English law by virtue of the "proper plaintiff principle"[28] and the "majority rule principle". Courts in both jurisdictions are reluctant to become involved in disputes concerning the internal management of partnerships.[29] In Watson v Imperial Financial Services Limited,[30] the British Columbia Court of Appeal applied the rule in Foss v Harbottle[31] in the context of a claim by limited partners against a bank for breach of trust, where the general partners did not wish to pursue the claim. The court held that the claim belonged to the partnership and not the individual partners, notwithstanding that the partnership was not a separate legal entity.[32] The undesirable complexities of Foss v Harbottle thus arise under existing partnership law whether the partnership has or has not got separate personality.
11.22 We suggested that there were three options. First, partners could owe duties to the partnership and not to their partners. We did not favour this option as it would promote the use of derivative actions in partnership at a time when we are recommending the replacement of such actions in company law.[33] The second option was that partners should owe duties to the partnership but that certain duties, such as the duty of skill and care and the duties to account for profits and not to compete with the partnership, would be owed both to the partnership and to other partners. The drawback of this option is that a partner may seek to pursue claims for breach of duty in circumstances where a majority of partners acting in good faith is prepared to waive the claim. The third option was that partners should owe each other a general duty of good faith and duties to give accounts and information concerning the partnership but that other duties[34] should be owed to the partnership. While recognising the complexity of option 3 we provisionally proposed that it was the appropriate option.[35] We also proposed that (if option 3 were preferred) a partner should be able to commence an action on behalf of the partnership to enforce duties owed to the partnership, subject to a disclaimer of the action by a majority of the partners acting in good faith on behalf of the partnership.
Consultation
Duty of good faith11.23 Consultees unanimously supported the idea that there should continue to be a duty of good faith in relations between partners. Several suggested that the duty was an essential characteristic of partnership. A majority of consultees supported a statutory statement of the duty of good faith but some expressed concern that that might alter the extent of the duty or hinder the development of the law.
Duty of skill and care11.24 The majority of consultees opposed the proposal for a statutory statement of the duty of skill and care. Several expressed concern that a statutory definition might lead to litigation between partners. The Law Reform Committee of the General Council of the Bar, however, suggested that there was such a duty and that it should be stated in a Partnership Act. In Scotland there was more support for our provisional proposal (that in the absence of agreement to the contrary partners are expected to act with such care and skill as can reasonably be expected of those with the general knowledge, skill and experience that the partners have or purport to have) than for the other options. But the Faculty of Advocates preferred the subjective standard which looks to the knowledge, skill and experience which the partner actually has. In both jurisdictions, of the consultees who supported a statutory statement of the duty of skill and care, the majority supported our provisional proposal.
Persons to whom duties are owed11.25 There was support for a provision defining the persons to whom partners owe the duties which arise out of partnership but views were divided on the terms of that provision. The majority of consultees supported, or suggested variations to, the second option; namely that partners should owe duties to the partnership, but that certain duties, such as the duty of skill and care and duties to account for profits and not to compete with the partnership, would be owed to both the partnership and the partners. There was very little support for the option that partners should owe duties only to the partnership. But Professor Morse preferred this option combined with a rule that a partner should be able to commence an action on behalf of the partnership to enforce duties owed to the partnership, subject to disclaimer of the action by a majority of the partners acting in good faith on behalf of the partnership. Several consultees considered that all duties should be owed to the partnership and the partners. It was suggested that to provide otherwise was contrary to the ethos of partnership. There was only limited support for the third option (that partners should owe each other a general duty of good faith and duties to give accounts and information but that all other duties should be owed to the partnership) as many consultees thought that it was too complex. One consultee argued that the duties should be owed only to other partners.
11.26 Several consultees expressed doubt over our proposal (which was linked to option 3) that a partner should be able to commence an action on behalf of the partnership to enforce duties owed to the partnership subject to a disclaimer of the action by the majority of partners acting in good faith on behalf of the partnership. It was suggested that the majority should not have such a power as the litigation was not an "ordinary matter" within section 24(8) of the 1890 Act.[36]
Court power to grant relief11.27 Consultees were divided on the issue of whether to give the court power to relieve a partner from liability for breach of duty where he had acted honestly and reasonably. The strong weight of opinion in both jurisdictions was against the introduction of a relieving power.
Duty to devote a specified amount of time11.28 Almost all consultees agreed with our provisional proposal against a default duty to devote a specified amount of time to the partnership.
Reform recommendations
Duty of good faith11.29 As mutual trust underpins partnership and as the 1890 Act already includes several fiduciary duties, there is a case for stating in a Partnerships Act the general duty of good faith as between partners. A broadly worded statement of duty makes the law accessible without altering it or hindering judicial development of the duty.[37] We have considered whether to specify that partners owe a duty to act in good faith in the interests of the partnership. There is case law in support of such a formulation in both Scotland and Ireland.[38] It can be argued that it would be incongruous not to have a statutory statement of such a duty when other, more specific, fiduciary duties are stated in the 1890 Act. But on balance we think that it is sufficient to state a general duty of good faith in partnership matters[39] and to re-enact the specific fiduciary duties which are already stated in the 1890 Act.
11.30 Our policy therefore is that there should be a statutory statement that a partner must act in good faith towards the partnership and each of the other partners in relation to any matter affecting the partnership.[40] We consider that in the existing law this is a term of the partnership contract and in English law arises in equity. As this duty is fundamental to partnership we recommend that it should not be capable of being excluded by the partnership agreement. The precise duties encompassed within the general duty of good faith may vary depending on the circumstances of the particular partnership. Partners by their agreement may determine the nature and extent of the particular duties which they undertake to each other and to the partnership. We think however that it would be inconsistent with the partnership relationship for partners to be able to exclude the duty of good faith.[41]
11.31 We also favour the re-enactment of the more specific fiduciary duties (sections 28, 29 and 30 of the 1890 Act) which are consistent with the general duty of good faith but which may be modified by agreement. The power of partners to modify the specific duties is not absolute. In our view, it is subject to the overriding duty of good faith and therefore the modifications must be compatible with that overriding duty. It is open to partners to agree particular terms in their partnership agreement which may modify the application of the duty of good faith in that context. But whatever the partners agree as their mutual rights and duties, they must act in good faith in enforcing those rights and performing those duties. Thus we propose that the mutual rights and duties of partners (and the partnership) should be subject to the duty of good faith.
11.32 We recommend:
(1) That there should be a statutory statement that a partner must act in good faith towards the partnership and each of the other partners in relation to any matter affecting the partnership; (Draft Bill, cl 9(1))
(2) That that overriding duty of good faith, not being a default rule, should not be capable of being excluded by the partnership agreement and that partners must act in good faith in the context of the particular rights and duties to which they agree in their partnership agreement; (Draft Bill, cl 9(1) and (3))
(3) That the specific duties in sections 29 and 30 of the 1890 Act (to account for private profits and not to compete with the partnership) be re-stated as default rules in the draft Bill: in each case the partnership may consent to the receipt of the profits or the competition; (Draft Bill, cl 9(2), (5) and (6))
(4) That a partner must keep each of the other partners fully informed of matters affecting the partnership of which the other partners would reasonably expect to be kept informed;[42] (Draft Bill, cl 9(2) and (4))
(5) That any modifications of the rules in (3) and (4) above must be in ways that are compatible with the duty of good faith in (1) above. (Draft Bill, cl 9(3))
Partners' duties in relation to accounting and partnership records11.33 We consider that the duty in section 28 of the 1890 Act to render true accounts to any partner or his legal representatives and the rule in section 24(9) of the 1890 Act in relation to access to inspect partnership records should be more clearly expressed. We think that a distinction should be drawn between the records which a partner keeps of the transactions in which he personally is involved and the wider records of the partnership which are necessary to compile a firm's accounts. A partner should be under a duty to ensure that the former records are kept and made available. The partner should also be under a duty to co-operate in the drawing up of partnership accounts and to secure the retention of the firm's records. We see no need to preserve the default rule that the partnership books should be kept at the firm's principal place of business.
11.34 We therefore recommend, as default rules, that:
(1) A partner should be under a duty to ensure that proper accounting records are kept of transactions affecting the partnership in which he is involved and of which the other partners would reasonably expect such records to be kept;
(2) A partner should be under a duty to ensure that such records are made available, on request, to the partnership and each of the other partners; and
(3) A partner should be under a duty to co-operate with any person who keeps partnership records or draws up partnership accounts on behalf of the partnership. (Draft Bill, cl 15)
A duty of disclosure to and by an incoming partner11.35 The general law imposes certain duties on persons who are negotiating their entry into partnership.[43] But the scope and characterisation of those duties is not clear.[44] In particular it is not clear whether a sole trader who wishes to take on a partner or an existing partnership which wishes to recruit an additional partner is under a positive duty to disclose to the prospective partner information which is material to his decision whether to enter into partnership.
11.36 We think that it is important to establish the existence of such a duty. The relationship between partners, once the partnership has started, is one of good faith.[45] It is consistent with this concept of partnership that people who wish a person to join them in a partnership should be obliged to inform him about what he is entering into. Proper disclosure is particularly important where a pre-existing partnership is negotiating with a prospective incoming partner. While the incoming partner under the proposed default regime would not incur secondary liability for pre-existing obligations,[46] he could incur indirect liability for such obligations. Such indirect liability would arise if, at the time he joins or thereafter, an existing partner withdraws from the partnership and receives an indemnity from the persons who continued in the partnership.
11.37 We do not recommend a legislative statement of the extent of any duty of good faith towards a prospective partner. That can be left to the general law, which is developing. In any event we consider that the duty of disclosure is an incident of the parties' intention to enter into a relationship of the utmost good faith rather than a manifestation of that yet-to-be created relationship.[47] But we think that it would be useful to include a statutory duty of disclosure which a person, or the partners of an existing partnership, should owe to a prospective partner.
11.38 There needs to be a limit on the information which must be disclosed. We think that the duty of disclosure should extend to all information which a hypothetical prospective partner would reasonably expect to receive in order to decide whether to enter into partnership. In addition that duty should be capable of waiver: an incoming partner may agree to enter into partnership on incomplete information because he trusts his prospective co-partners.
11.39 The incoming partner should have a similar duty of disclosure to his prospective partners extending to all information which a hypothetical prospective partner would reasonably expect to receive in order to decide whether an incoming partner should join the partnership. Again this duty should be capable of waiver.
11.40 We therefore recommend that persons who negotiate to enter into partnership with a prospective partner should be under a duty to disclose to the prospective partner anything known to them (or which they reasonably ought to have known) which a (hypothetical) prudent prospective partner would reasonably expect to be disclosed in order to decide whether to enter into partnership with those persons. This duty may be waived by the prospective partner. In return the prospective partner should be under a duty to disclose to the other prospective partners (or partners in an existing partnership which he plans to join) anything known to him (or which he reasonably ought to have known) which a (hypothetical) prudent partner would reasonably expect to be disclosed in order to decide whether to enter into partnership with the prospective partner. Again, that duty may be waived. (Draft Bill, cl 10)
Duty of skill and care11.41 Since receiving the responses to the Joint Consultation Paper we have revised our views on the formulation of a statement of a partner's duty of care and skill. Although a majority of those consultees who supported a statutory statement favoured our provisional proposal (that in the absence of agreement to the contrary partners are expected to act with such care and skill as can reasonably be expected of those with the general knowledge, skill and experience that the partners have or purport to have) we have come to question whether there should be a statutory formulation of the duty of care.
11.42 We have become aware of the diversity of views on the appropriateness of partners being liable to each other in negligence for mistakes made in the course of partnership business. In the conference on partnership law organised by the Institute of Advanced Legal Studies in June 2001 many expressed the view that it was not consistent with the ethos of most partnerships that partners should litigate against each other concerning failures to exercise reasonable care in carrying on partnership business.
11.43 This has caused us to review the arguments for and against the formulation of the duty of care.
The options11.44 There are four options in relation to the duty of care as between partners. At one extreme there is the option of providing that partners owe each other no duties of care because they have come together to pool their skills and share the risks of so doing. At the other extreme there is the option of imposing in all circumstances an objective standard of care by reference to the standard of the competent businessman, without taking account of the fact that the parties are partners (which may justify some tolerance of error on each other's part) and the circumstances of the particular partnership.
11.45 We do not see a case for either of the extreme options and therefore consider, first, the arguments for and against a statutory formulation of a restricted duty and, secondly, the arguments for and against the statutory formulation of a duty of reasonable care.
Arguments in favour of a restricted duty11.46 Partners accept their partners for better or for worse. Partners in a partnership agreement might choose to impose such a duty of care on each other but it should not be part of the default code. Partnership is a co-operative venture involving the pooling of effort and the sharing of risks inherent in the ordinary course of business.[48] It is not appropriate that partnership should follow company law, which in recent years has imposed an objective standard of care on directors. The recent Australian case of Lane v Bushby[49] is consistent with this view.[50]
11.47 As case law contains a number of conflicting formulations of the standard of care,[51] it is not prudent to ignore the uncertainty which has been created. Partners should owe each other duties not to cause personal injury or death or physical damage to a partner's private property through lack of reasonable care. But it is not appropriate to the default regime that partners should have implied liability to each other in damages for economic loss to the partnership or physical damage to partnership property caused by mere lack of reasonable care in carrying on business. For liability in damages to be incurred a greater degree of culpability is required. Otherwise the law will be encouraging litigation between partners. In the nineteenth century, the courts imposed liability for "culpable negligence" or "gross negligence".[52] More recently RUPA has provided a restricted formulation of the default rule of a partner's duty of care:
A partner's duty of care to the partnership and the other partners in the conduct and winding up of the partnership business is limited to refraining from engaging in grossly negligent or reckless conduct, intentional misconduct, or knowing violation of the law.[53]
Arguments against a statutory restriction of the duty of skill and care11.48 A statutory definition of the default standard of care is unnecessary. A duty of care does not exist in abstract. The circumstances in which a duty of care arises will determine the content of that duty.[54] In some forms of partnership it may be appropriate to imply a duty by one partner towards the others; in others it may not.
11.49 The circumstances of different partnerships are so variable that a legislative rule would create hardship in certain cases. If the standard of care were, as in RUPA, restricted to gross negligence, unacceptable results could follow. For example, the professional partner on whom the passive partner relied in Gallagher v Schulz[55] might escape liability for his carelessness. This seems unfair as there are circumstances in which a partner should have a claim in ordinary negligence against another partner.
11.50 It would be anomalous to restrict the standard of care owed by a partner to the partnership and the other partners. It is an implied term of a contract of employment that an employee is to use reasonable care in the performance of his work.[56] Thus a salaried partner, who in a particular case is an employee, would on becoming an equity partner owe a less onerous duty of care to the partnership and the other partners. Suppose a salaried partner and an equity partner are jointly careless. The firm suffers significant loss and sues the salaried partner. The salaried partner as an employee would be liable but would not be entitled to any contribution from the equity partner unless he could prove gross negligence. Again this seems unfair.
11.51 In any event, it is difficult to give content to concepts such as "gross negligence" or "gross carelessness". There are varying degrees of negligence and it is difficult to say what is the precise point at which ordinary negligence ends and gross negligence begins.
11.52 Finally, it is argued that we are dealing only with a default rule. If a partnership wishes to restrict the standard of care owed by its partners to the firm and the other partners, it can do so by contracting out of the default code.
Arguments in favour of a statutory statement of an objective standard of reasonable care11.53 It is anomalous that partners, who are carrying on a business for mutual benefit, do not owe each other duties of care which are measured by an objective standard. Directors and trustees are now expected to attain an objective standard of care.
11.54 The standard of reasonable care is flexible and takes account of the circumstances in which the duty of care arises. It would equate the standard of care owed by an employee with that owed as between partners.
Arguments against a statutory statement of an objective standard of care11.55 While the objective standard would avoid some of the anomalies which would arise from a restricted standard, it is not consistent with the ethos of many partnerships, and in particular small partnerships, that partners should litigate against each other concerning failures to exercise reasonable care in carrying on partnership business. The arguments in paragraph 11.46 above apply. In addition the standard would only be a default rule. Partners wishing to impose a particular standard of care on each other can do so in their partnership agreement.
Our conclusions11.56 We have concluded that we should not recommend a statutory statement of the default standard of care of a partner.
A restrictive definition of duty11.57 We did not consult on the introduction of a restrictive definition in the Joint Consultation Paper and there was no consensus among those whom we have since consulted when formulating our recommendations. While there are those who feel strongly that there is a need, in the interest of the stability of partnerships, to restrict the spread of litigation between partners, there are also those who think that the general law relating to duty of care should apply to partners unless they contract to restrict the scope of their duties to each other.
11.58 We are aware also of the difficulty of formulating a restricted duty. In the Joint Consultation Paper we criticised the expressions "gross negligence" and "culpable negligence" as being difficult and unclear.[57] The use of the expression "gross negligence" in nineteenth century cases may mislead as it is not clear whether it imported more than what a modern lawyer would call negligence. While the concept of gross negligence has a place in Scots law and in English criminal law, it has been widely criticised in English case law in civil cases.[58] We have concluded that it would not be an appropriate formulation.
11.59 We considered using a concept of "gross carelessness" which is a concept which the Law Commission have used in their recommendations on involuntary manslaughter.[59] This would have involved an objective standard of reasonable care but a partner would not incur liability to make reparation to the partnership or his partners for damage to partnership property or economic loss to the partnership (and thereby the partners) unless his conduct of partnership business fell far below the objective standard of reasonable care. We encountered considerable difficulty in formulating the standard in a way which would be easy to apply.
11.60 We recognise that if we adopted this approach there would be hard cases, for example, where one partner who may be a passive investor relied on the expertise and professional skill of the other.[60] It would also be more difficult for a partnership to claim in the case, suggested by a consultee, where a partnership charges a particular partner with responsibility for renewing a fire insurance policy and suffers loss when he fails to do so and the partnership's premises are destroyed by fire. A consequence of a restrictive definition would be that in order to impose liability on a partner for damage to partnership property or financial loss to the partnership (and thus the partners) through mere negligence, it would be necessary for the partnership or the other partners either (a) to include such a duty as a term of the partnership agreement or (b) to demonstrate that the partner had assumed personal responsibility for the particular task which imported liability for lack of reasonable care.[61] This would involve something more than merely being the managing partner or accepting an instruction or request to carry out the task in the ordinary course of partnership business. We are concerned that a restrictive default rule would thus give rise to hard cases and complexity.
11.61 On balance therefore, we think that it is not appropriate to introduce a restrictive definition of the standard of care but to leave it to partners to contract to restrict the standard of care which they may expect from each other.
An objective standard of care11.62 We have also concluded that it is not desirable to include in the draft Bill a statutory formula setting out an objective standard of care. As we stated in the Joint Consultation Paper:[62]
11.63 These points have added force where the partner has been inadequately trained within the firm and is later criticised for adopting a course of action which he had been taught to adopt.[63]The essence of a partnership is the personal relationship between the partners. It can be argued that the expectation of a partner's skill derives from this personal assessment, and not from a perception of what level of skill is considered reasonable for the position of partner. … A partner cannot expect more skills of co-partners than they actually possess, but can reasonably expect that they will be as careful in partnership affairs as they would be in their own.
11.64 In some recent cases the court has acknowledged the existence of a duty of care as between partners and treated the standard of care as the objective standard of reasonable care.[64] But in deciding what is reasonable the court requires to take account of the existence of the partnership relationship and the circumstances of the particular partnership. In many firms, partners have or should have knowledge of a particular partner's ability and experience when he joins the firm. With that knowledge the partners have agreed to pool risks with the particular partner. There must therefore be some tolerance of error. In addition the practices of the partnership are relevant - issues such as the risks which the partners habitually take in the conduct of business and the way in which a partner has been instructed to carry on business within the partnership will have an impact on the reasonableness of his behaviour. Circumstances will vary greatly as between partnerships. It would be very difficult to devise a simple statutory formulation which would articulate these considerations.
11.65 We have concluded therefore that it is better to leave it to partners to formulate in their partnership agreements the standard of care which they expect of each other and, in the absence of such a formulation, to the courts to apply the standard of reasonable care in a way which takes account of the circumstances of the particular partnership.
11.66 We therefore recommend that there should not be a statutory default definition of the standard of care owed by a partner to the partnership and the other partners.
Persons to whom the partners owe duties11.67 We have also reviewed our policy on the persons to whom partners should owe duties. We are persuaded that the approach which we adopted in the Joint Consultation Paper is unduly complex. It would be simpler if the partner's duty of good faith were stated to be owed both to the partnership and to the partners. We also believe that this is sound in principle. For example, under clause 9 of the draft Bill a partner must account to the partnership for any profits from carrying on a competing business without the consent of all the other partners. Any partner should be entitled to bring an action for an account against a partner who acted in breach of that obligation, although procedurally it would be appropriate for the partnership and all the partners to be made parties to the action both because the accounting should be to the partnership and in order that all should be bound by the result.
11.68 We note that the Limited Liability Partnerships Regulations 2001[65] adopt a similar approach in their default provision for LLPs. Regulation 7 provides that the mutual rights and duties of the members, and the mutual rights and duties of the LLP and the members shall be determined, subject to the provisions of the general law and to the terms of any limited liability partnership agreement, by the rules which it then lays down. Those rules include the duty to render accounts to any member, the duty to account to the LLP for profits made in competition with it, and the duty to account to the LLP for private profits.[66] We interpret this as providing that the specified duties are owed both to the LLP and the members.
11.69 To achieve this result, we propose that the draft Bill should provide that the duties specified in clause 9 are owed to, and enforceable by, both the partnership and the partners. We do this by providing that the overriding duty of good faith is owed to the partnership and each of the other partners and by particularising certain of the specific duties which arise from that overriding duty.
11.70 We therefore recommend that partners should owe all duties arising out of the duty of good faith both to the partnership and to the partners. (Draft Bill, cl 9(1))
No court power to grant relief11.71 In view of the lack of support from consultees we see no pressing need to empower the court to relieve partners from liability for breach of duty if they have behaved honestly and reasonably. We therefore do not recommend that the court should be empowered to relieve partners from liability for breach of duty if they have acted honestly and reasonably.
No duty to devote a specified time to the partnership11.72 We are persuaded that it would not be appropriate to have a default rule that partners should devote their full time and attention or a specified amount of time to the partnership. Any rule would be inflexible and potentially unhelpful. Where partnerships wish to specify the amount of time and attention partners should give to the partnership business, they are free to do so. We do not recommend that there should be a default rule imposing a duty to devote a specified amount of time to the partnership.
Note 1 Finn, Fiduciary Obligations (1977) p 3-4. [Back] Note 2 Helmore v Smith (1885) 35 Ch D 436, 444, per Bacon V-C. [Back] Note 3 See Finn, Fiduciary Obligations (1977) p 1, where he warns that the description “fiduciary” is meaningless without a consideration of the particular rules and principles to which that description is applied. [Back] Note 4 1890 Act, s 29(2) and R W Pathirana v A Pathirana [1967] 1 AC 233, 240; Thompson’s Trustee in Bankruptcy v Heaton [1974] 1 WLR 605, 613; Chan v Zacharia (1984) 154 CLR 178, 197. [Back] Note 5 Bury v Allen (1845) 1 Coll 589, 604; 63 ER 556, 562; and Thomas v Atherton (1878) 10 Ch D 185, 199. [Back] Note 6 There are references in older English cases to a partner’s “want of reasonable care” (Thomas v Atherton (1878) 10 Ch D 185, 202) and to a partner being “guilty of negligence” (McIlreath v Margetson (1785) 4 Doug 278, 279, 99 ER 880). [Back] Note 7 Winsor v Schroeder (1979) 129 NLJ 1266. [Back] Note 8 (1988) 2 NZBLC 103, Williamson J. [Back] Note 9 Mair v Wood 1948 SC 83, 90: Blackwood v Robertson 1984 SLT (Sh Ct) 68. See also Stair Institutions I.16.7, Erskine Institute III.iii.21 and Justinian Institutes III.xxv.9. [Back] Note 11 In that case an allegation that the defender had been negligent in carrying out a conveyancing transaction was answered by the assertion that that was how the partnership had taught him to transact when they trained him as a solicitor. See 2000 SLT 699, 701J. [Back] Note 12 We understand that the pursuer partnership withdrew their claim before the hearing was complete after the judges in the Extra Division had expressed dissatisfaction with the idea that partners, in the absence of express stipulation, should owe each other duties of care in relation to loss incurred by the partnership as a result of claims by clients for professional negligence. As a result the Inner House issued no opinions. [Back] Note 13 [2000] NSWSC 1029. [Back] Note 14 “The firm must indemnify every partner in respect of payments made and personal liabilities incurred by [the partner] … in the ordinary and proper conduct of the business of the firm”. [Back] Note 15 (1878) 10 Ch D 185. [Back] Note 17 1890 Act, s 28. [Back] Note 18 1890 Act, ss 29 and 30. [Back] Note 19 SeeLindley & Banks, para 20-47. [Back] Note 20 Companies Act 1985, s 727, Trustee Act 1925, s 61 and Trusts (Scotland) Act 1921, s 32 . [Back] Note 21 Finn, Fiduciary Obligations (1977) ch 15 describes the duties of good faith being “certain standards of good conduct” which equity exacts “from persons who are so circumstanced in their relationships with others that they cannot be considered as being ‘at arm’s length’.” He analyses the duties of good faith under eight headings: undue influence, the misuse of property held in a fiduciary capacity, the misuse of information derived in confidence, purchases of property dealt with in a position of a confidential character, conflict of duty and interest, conflict of duty and duty, renewals of leases and purchases of reversions and inflicting actual harm on an “employer’s” business. These headings are useful to show the wide scope of the duties of good faith which can arise in particular circumstances. [Back] Note 22 Joint Consultation Paper, para 14.17. [Back] Note 23 The court has analogous powers in relation to trustees and company directors – see Trusts (Scotland) Act 1921, s 32, Trustee Act 1925, s 61 and Companies Act 1985, s 727. [Back] Note 24 Joint Consultation Paper, para 14.6. [Back] Note 25 Joint Consultation Paper, para 14.32. [Back] Note 26 Company Directors: Regulating Conflicts of Interest and Formulating a Statement of Duties (1999) Law Com No 261; Scot Law Com No 173 and, in particular, Appendix A. The Company Law Review has since adopted a formulation of the director’s duty of care which is substantially similar to our recommendation. See Modern Company Law for a Competitive Economy, Final Report Vol 1, para 3.10 and Annex C, p 346. [Back] Note 27 This is the standard which we recommended for company directors in our report Law Com No 261; Scot Law Com No 173. See footnote 26 above. [Back] Note 28 That principle is that “A cannot, as a general rule, bring an action against B to recover damages or secure other relief on behalf of C for injury done by B to C”. See Prudential Assurance Company v Newman Industries Limited (No 2) [1982] Ch 204, 210. It is applied to associations which do not have legal personality as well as to companies which do: Edwards v Halliwell [1950] 2 All ER 1064 (CA), 1066 per Jenkins LJ. [Back] Note 29 See Lord Eldon in Carlen v Drury (1812) 1 V & B 154, 158; 35 ER 61, 62. [Back] Note 30 (1994) 111 DLR (4th) 643. See also Lord Lindley quoted in Lindley & Banks, 23-15. [Back] Note 31 (1843) 2 Hare 461, 67 ER 189, ie the proper plaintiff principle. [Back] Note 32 But the claim could proceed in the name of the partners if they were able to bring themselves within the fraud on the minority exception toFoss v Harbottle. See also Lee v Block Estates [1984] 3 WWR 118, British Columbia Supreme Court, McEachern CJSC. That case involved an attempt by partners to enforce against other partners an obligation owed to the partnership. The judge referred in his judgment (p 140) to many American authorities which applied the proper plaintiff principle to partnerships. [Back] Note 33 See Law Commission Report: Shareholder Remedies (1997) Law Com 246. [Back] Note 34 The duty to account for profits, the duty not to compete in business against the partnership, the duty to act in good faith in the interests of the partnership and the duty of care and skill. [Back] Note 35 Joint Consultation Paper, para 15.21. [Back] Note 36 See our recommendation in this regard: para 10.30(3) above and draft Bill, cl 14(5). [Back] Note 37 See our recommendation of a statutory statement of directors’ duties in our report: Company Directors: Regulating Conflicts of Interests and Formulating a Statement of Duties (1999) Law Com No 261, Scot Law Com No 173, Part 4. [Back] Note 38 Finlayson v Turnbull 1997 SLT 613 and Irish Press plc v Ingersoll (unreported) High Court, 15 December 1993 (see Twomey, para 5.13). [Back] Note 39 This is a broader formulation than a duty to act in good faith in the interests of the partnership as the latter concentrates on the duty owed to the firm while the former covers also the duties owed by the partners in their relations with each other. [Back] Note 40 For the persons to whom these duties are owed see paras 11.67 – 11.70 below. [Back] Note 41 The current editor of Lindley & Banks (para 16-09) expresses a tentative view that partners can exclude all elements of the duty of good faith because the duty is not part of the statutory definition of partnership, but he points out that it is difficult to imagine circumstances in which partners would do so. [Back] Note 42 This, together with the recommendations in relation to accounting and partnership records (see paras 11.33 – 34 below) replaces the 1890 Act, s 28. [Back] Note 43 SeeLindley & Banks, para 16-06; Blackett-Ord, Partnership, para 10.11. [Back] Note 44 There are cases where omission to give information in a prospectus is misleading and gives rise to liability: New Brunswick Railway v Muggeridge (1860) 1 Dr and Sm 363, Central Railway Co of Venezuela v Kisch (1867) LR 2 HL 99. Liability may arise under the law of agency where a prospective partner who is also agent of the proposed partners takes a secret commission: Fawcett v Whitehouse (1829) 1 Russ & M 132. In addition the law prevents the misuse of confidential information which is disclosed in the course of negotiations towards a possible partnership: LAC Minerals Ltd v International Corona Resources Ltd [1990] FSR 441 (Supreme Court of Canada). [Back] Note 45 See para 11.3 above. [Back] Note 46 See para 6.80 above. [Back] Note 47 In an obiter dictum in Bell v Lever Brothers [1932] AC 161, 227 Lord Atkin stated: “There are certain contracts expressed by the law to be contracts of the utmost good faith, where material facts must be disclosed; if not, the contract is voidable. Apart from special fiduciary relationships, contracts for partnership and contracts of insurance are the leading instances. In such cases the duty does not arise out of contract; the duty of a person proposing an insurance arises before the contract is made, so of an intending partner.” [Back] Note 48 SeeHurst v Bryk, Carnwath J, 11 April 1995 (unreported). [Back] Note 49 [2000] NSWSC 1029. [Back] Note 50 See para 11.9 above. [Back] Note 51 See para 11.6 – 11.10 above. [Back] Note 52 See Bury v Allen (1845) 1 Coll 589; 63 ER 556; Thomas v Atherton (1878) 10 Ch D 185. [Back] Note 53 This standard is consistent with pre-RUPA case law in the United States: see Hillman, Vestal & Weidner, The Revised Uniform Partnership Act (2003 ed) pp 193-195. Prosser and Keeton on Torts (5th ed 1984) p 212 suggests that “gross negligence” has no generally accepted meaning; “but the probability is, when the phrase is used, that it signifies more than ordinary inadvertence or inattention, but less perhaps than conscious indifference to the consequences”. [Back] Note 54 See, for example, Midland Bank v Hett, Stubbs and Kemp [1979] Ch 384, 434 per Oliver J. [Back] Note 55 (1988) 2 NZBLC 103, Williamson J. See para 11.7 above. [Back] Note 56 Lister v Romford Ice and Cold Storage Co Ltd [1957] AC 555. A paid agent may owe a similar duty of care in contract and in tort: see Chaudhry v Prabhakar [1989] 1 WLR 29. [Back] Note 57 Joint Consultation Paper, para 14.25. Rolfe B (later Lord Cranworth) famously stated in Wilson v Brett (1843) 11 M & W 113, 115; 152 ER 737, 739 that he “could see no difference between negligence and gross negligence, that it was the same thing with the addition of a vituperative epithet”. See also Pentecost v London District Auditor [1951] 2 KB 759, 764 per Lynskey J; Houghland v R..R.. Low (Luxury Coaches) Ltd [1962] 1 QB 694, 697-8 per Ormerod LJ. In Scots law, see Hunter v Hanley 1955 SC 200, 206 & 207. In any event it is impossible to draw a hard and fast line between “mere” negligence and gross negligence orculpa lata, but the judges may recognise gross negligence when they see it – Raes v Meek (1889) 16 R (HL) 31, 35 per Lord Herschell. See also Midland Bank Trustee (Jersey) Ltd v Federated Pension Services Ltd [1996] PLR 179 (Jersey Court of Appeal) and Armitage v Nurse [1998] Ch 241 (CA). See also the Law Commission’s discussion of the concept of gross negligence in Trustee Exemption Clauses, Consultation Paper No 171, paras 4.67 – 4.78. [Back] Note 58 See, for example, Armitage v Nurse [1998] Ch 241, 254 per Millett LJ. [Back] Note 59 See Legislating the Criminal Code: Involuntary Manslaughter (1996) Law Com No 237, para 5.34. [Back] Note 60 See for example Gallagher v Schulz (1988) 2 NZBLC 103. [Back] Note 61 See Williams and Another v Natural Life Health Foods Ltd [1998] 1 WLR 830. A contractual term excluding such liability might prevent a duty of care arising unless the disclaimer was unreasonable under the Unfair Contract Terms Act 1977: See Smith v Eric S Bush [1990] 1 AC 831. [Back] Note 62 Joint Consultation Paper, para 14.29. [Back] Note 63 This was part of the defence argument in Ross Harper & Murphy v Banks 2000 SLT 699. [Back] Note 64 See, for example, Winsor v Schroeder (1979) 129 NLJ 1266, Gallagher v Schulz (1988) 2 NZBLC 103 and Ross Harper & Murphy v Banks 2000 SLT 699. [Back] Note 65 SI 2001 No 1090. [Back] Note 66 For the rules in the 1890 Act see ss 28 to 30. [Back]
