Partnership Law [2003] SLC 192(5) (Report) (November 2003)

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URL: http://www.bailii.org/scot/other/SLC/Report/2003/192(5).html
Cite as: [2003] SLC 192(5) (Report)

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PART V

SEPARATE LEGAL PERSONALITY

Introduction

One can look at a partnership either as an aggregation of the individual partners or as an entity separate from its partners. English law has adopted the aggregate approach and many Commonwealth countries have adopted or adapted the English law of partnership. Scots law has an entity approach. The United States of America have recently moved from the aggregate approach to an entity approach in the enactment of the Revised Uniform Partnership Act (RUPA).

^[1]

Partnership operates in similar ways whichever approach is adopted. Although the conceptual bases are different, English law and Scots law tend to reach the same result in practical terms on most issues of partnership law.

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Consultation

Our proposal in the Joint Consultation Paper that English law should adopt an entity approach to partnership received support from many prominent consultees who represented a wide range of interests.

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As all of the Scottish consultees supported the retention of separate legal personality in Scots law, the discussion of the reasons for recommending separate legal personality concentrates on English law.

The reasons for recommending separate personality

Clarity and commercial perception

5.5

We believe that separate legal personality is the clearest way of explaining the nature of partnership, particularly if our recommendations for continuity of partnership are adopted.

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Many people in partnerships view the partnership as an entity. Many clients of partnerships take a similar view. As one consultee

^[7]

Partnerships often operate as though they were an entity. … Not only will [independent legal personality] bring the law into line with practice, it will make a legal reality of the relationship assumed by clients.

This has long been recognised. Lord Lindley summarised the commercial view of partnership in these words:

The partners are the agents and sureties of the firm: its agents for the transaction of its business; its sureties for the liquidation of its liabilities so far as the assets of the firm are insufficient to meet them. The liabilities of the firm are regarded as the liabilities of the partners only in case they cannot be met by the firm and discharged out of its assets.^[8]

English law provides otherwise.

By adopting the aggregate approach English law hinders continuity of partnership: a partnership, which is seen as a relationship between individuals or as a contract between individuals, ceases when the identity of the partners changes. A partnership comprising different individuals is a different relationship. But the commercial client who dealt with a partnership over time would be surprised to learn that a partnership had ceased to exist and that a new partnership had been created on each occasion when a partner retired or a new partner was admitted. The client would be surprised to learn that he had transacted with several different partnerships over time and that he might require to pursue legal remedies for past wrongs against different aggregations of persons. There is a gulf between the commercial perception of, and the legal characterisation of, partnerships.

5.9

The contrast between the commercial view and the legal view of partnership is borne out by the consultation responses which we received. It is notable that representative bodies of professions and businesses which operate in partnerships generally supported the introduction of separate legal personality.

A solution to practical problems

5.10

There is a widespread practice by which partners agree in their partnership agreements to continue in partnership on the withdrawal of a partner or the assumption of a partner. The introduction of continuity of partnership as a default rule would reflect this practice. English law, while retaining the aggregate approach, has adopted pragmatic solutions to overcome the incompatibility of the aggregate approach with continuity of partnership. The following are examples.

Existing pragmatic solutions

5.11

In litigation, the Civil Procedure Rules (CPR) allow a court action by or against a partnership to be in the name in which the partners carried on business when the cause of action accrued.

^[9]

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The English partnership is treated as if it were a separate legal entity for the purposes of Value Added Tax. Section 45 of the Value Added Tax Act 1994 provides that persons carrying on business in partnership may register for VAT in the name of the partnership and that no account is to be taken of changes in the membership of the partnership. H M Customs and Excise thus administer VAT as if partnerships already have continuing separate legal personality. By contrast, the Inland Revenue taxes partners as individuals and ignores the existence of the partnership for the purposes of income tax and capital gains tax. We understand that this approach

^[11]

^[12]

The 1890 Act itself attempts to reconcile the aggregate approach with economic reality, particularly where a partnership business continues on a change of members, in several provisions which appear to assume that the partnership is something different from the members at any one time. Thus sections 10 and 11 of the 1890 Act speak of the "liability of the firm" for certain losses; section 17(1) of a person being admitted as a partner "into an existing firm"; section 17(2) of a person who "retires from a firm". But the Act is not consistent: other provisions suggest that a new partnership is constituted on a change in membership.

^[13]

Practical problems

(a) The approach of leading textbooks

Leading textbook writers on partnership law have identified many practical problems resulting from the aggregate approach and the lack of legal personality.

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There are many problems associated with this lack of legal personality. Not least are the practical difficulties in relation to the ownership of property and the continuation of contractual rights and obligations of the partners when there is a change in the membership. If X contracts with A, B and C as partners, how does that continue if, say, either A leaves the firm or D joins it?^[16]

Lindley & Banks also focuses on the problems which can occur on a change in the partners:

Because the firm name represents no more than a convenient means of describing the partners who for the time being make up the firm, whenever the partners change that name must take on a new meaning. This can lead to a number of complications.^[17]

The current editor then lists a number of examples of such complications,

^[18]

An authority given to two partners to take out insurance in their names does not authorise them to insure in the names of themselves and a third party whom they subsequently take into partnership. Similarly, if a firm, A, B and C, has an agent D, and C retires, D may continue to be agent of the firm but he will in reality be the agent of A and B, but not C.

Higgins and Fletcher, in their textbook on partnership in Australia and New Zealand, suggest that the refusal to recognise the partnership as a legal entity, distinct from its constituent members, has in the past caused many difficulties some of which, such as the rules relating to partnership litigation, have been solved by legislation. They criticise the aggregate approach as leading to "a high degree of artificiality" when it is necessary to distinguish the property of the individual partner from the common property of the partnership and for creating intricate problems on insolvency.

^[19]

(b) The approach of the courts

The courts have tried to reconcile the law with commercial reality. A good example of the modern attitude of the courts is Sheppard & Cooper Ltd v TSB Bank plc.

^[20]

… it is submitted that we should so construe this agreement that it relates only to the persons who were the partners of the firm at the date of the letter. … I do not believe that that is a realistic construction of the letter in accordance with normal commercial practice today. When you have a big firm of accountants, or solicitors for that matter, a reference in a contract of this nature to "the firm" must, in my view, be taken to mean the partners for the time being of the firm, whenever the time arises.^[21]

This approach to the construction of contracts with a partnership, which is sometimes called a contract "with the house", avoids absurdity where the parties must have intended that the contract would survive changes in the membership of a partnership.

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Enforcement of partnership debts

The rules on the liability for, and enforcement of, partnership debts where there is a continuing partnership business would be much simpler in relation to a partnership with separate legal personality which adopted our default rule of continuity of partnership. The creditor of a continuing partnership would be able to enforce a judgment against the assets of the partnership as well as against the assets of the partners who were partners at the time when the obligation was entered into or the wrong occurred.

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Transfer of partnership property

There may be some doubt as to how English law provides for the transfer of property on a change of membership in a continuing partnership. In theory at least, the aggregate approach to partnership creates a problem for a continuing partnership. Where a partnership is initially the aggregate of A, B and C but A resigns and D is admitted as a partner, a new partnership comes into being as the aggregate of B, C and D.

^[27]

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Section 20 of the 1890 Act provides that partners are to hold and apply partnership property exclusively for the purposes of the partnership and that land is held in trust for those beneficially interested in the land. Complications can arise on a change in membership of a firm. Where land is held in trust for the partnership, the incoming partner need not become a trustee but would on joining the firm become entitled beneficially as tenant in common. A retiring partner normally ceases to be beneficially entitled on retirement. He may also choose to retire as trustee as well. In some circumstances, where there have been significant changes in the membership of the firm, it may be desirable to transfer the land to new trustees.

5.23

Again, separate legal personality would simplify this: the continuing partnership could hold property, including land, in its own name or be the beneficiary of a trust in which trustees hold property for it.

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Partnership insolvency

The adoption of an entity approach which allows a partnership to hold property in its own name or to have property held in trust for it should also help to clarify what belongs to the partnership and what comprises the partners' separate estates. This should simplify the reform of partnership insolvency in England and Wales. It is proposed that there will be a review of the Insolvent Partnerships Order 1994 in the light of our recommendations in this report.

^[31]

Conceptual clarity

We have been struck by the lack of clarity in English law on the conceptual basis of partnership. In particular, the recent case of Hurst v Bryk has revealed considerable uncertainty as to the respective roles of contract law and equity in partnership law.

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^[33]

Mullins v Laughton

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The introduction of separate legal personality will give statutory form to this approach. The draft Partnerships Bill will provide the framework in which a partnership comes into existence and is terminated. The grounds of termination will be those, if any, which the partners agree upon in their partnership agreement and those set out in the Bill.

^[35]

Although we recommend curtailing the use of contractual doctrine as a means of terminating a partnership, the partnership agreement, which will either be the terms agreed by the partners or the implied terms of the default code, will provide a constitution for the partnership. In addition, the rules of equity,

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Consistency with other developments in partnership law

Scotland

Scotland has long had an entity–based partnership law which in practice operates in a very similar way to English law. The entity approach has not caused difficulty except in the failure of Scots law to provide clearly for continuity of personality on changes in the membership of a partnership. Our recommendations in this report seek to remedy that lack of follow-through in the Scottish entity approach.

5.29

The adoption of an entity approach in English law enables us to recommend a coherent approach to partnership in the two British jurisdictions. But while that is a desirable end in itself, it is a secondary consideration beside the practical benefits which the entity approach can provide.

Europe

5.30

Many European jurisdictions confer some degree of legal personality on commercial partnerships in a variety of ways. The jurisdictions include France, Luxembourg, Norway and Sweden. Belgium, Germany, the Netherlands and Switzerland have partnerships which do not have legal personality but have certain attributes which are consistent with legal personality such as the ability to sue and be sued, the right to hold property, or the postponement of a creditor's recourse against the partners until he has exhausted his remedies against partnership assets. In December 2002 a Bill was introduced in the Netherlands Parliament to replace their ordinary partnership,

The United States' experience

The law of partnership in the United States is closer to the partnership models in the British jurisdictions than the European models and we have derived much help from persons who were involved in drafting RUPA.

5.32

In the United States, the debate between the "entity" and "aggregate" schools has a long history.

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The UPA did not settle the nature of partnership. Its original chief drafter, Dean Ames, would have defined a partnership as "a legal person" in the act. Dean Lewis who became the chief drafter after the death of Ames, was unwilling to go so far and said that the act did not embody the legal person theory. He did retain most of the specific entity-based provisions … since these solved the major problems that motivated the act.^[44]

In 1994, in RUPA, the issue was unambiguously resolved in favour of the entity theory. Section 201 provides simply:

A partnership is an entity distinct from its partners.

5.34

From our study of the commentaries, and discussion with those involved,

^[45]

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This aspect of RUPA has not proved controversial. Bromberg and Ribstein

^[47]

The aggregate/entity question has led to much confusion in partnership cases … RUPA's forthright entity characterisation is helpful for two reasons. First, it is an accurate description of partnership law (although it does not completely square with partners' individual liability for partnership debts). Second, clear adoption of the entity theory should help to end the courts' flip-flopping from one theory to another when they attempt to justify results with reference to the nature of partnership.^[48]

Since 1994 most States have adopted RUPA. While the treatment of partners' duties in RUPA has given rise to some controversy, we are not aware of any problems arising from the introduction of the entity approach into United States partnership law.

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Summary

In summary we consider that the entity approach brings the law closer to the commercial perception of how a partnership works. We see it as an effective solution to practical problems. It is also much easier to understand and explain to non-experts than some of the pragmatic solutions which English law has adopted to problems which are created by the aggregate approach. That is an important consideration in law reform particularly in relation to small business ventures. We observe that the entity approach has worked for over two centuries in Scotland without causing problems.

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Partnership – a sui generis entity

Adopting an entity approach to partnership does not mean that a partnership becomes a body corporate. We do not wish to import the often-antiquated rules of the common law of corporations into partnership law.

^[52]

A partnership will be a sui generis entity. Its characteristics will be determined by (a) the draft Partnerships Bill except so far as the provisions of that Bill are variable and varied by contract, (b) the terms of the partnership contract (if different from the default code in the Bill) and (c) the rules of common law and equity so far as not inconsistent with the express provisions of the Partnerships Bill. Although the draft Partnerships Bill does not include this formulation, it underpins our approach to partnership law reform and it is appropriate that we include it as a formal recommendation.

5.40

We recommend that:

(1) A partnership should have legal personality separate from the partners but should not be a body corporate; (Draft Bill, cl 1(3)).

(2) A partnership should be viewed as a legal person whose characteristics are determined by (a) the draft Partnerships Bill except so far as varied by contract, (b) the terms of the partnership contract (if different from the default rules of the Bill) and (c) the rules of common law and equity so far as not inconsistent with the express provisions of the draft Partnerships Bill.

Certain consequences

The partnership as a partner

5.41

A partnership which is a separate legal entity (partnership A) will be able to be a partner in another partnership (partnership B), just as a registered company can be. Instead of each of the partners in partnership A being partners in partnership B, partnership A itself will be the partner.

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A statement of capacity

As a partnership will be a separate legal entity, and to avoid the application of the rules of ultra vires, we have recommended that the draft Bill should contain a statement that the partnership, as a legal person, has unlimited capacity to act.

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Transitional provisions

As the introduction of separate personality and, more significantly, the introduction of continuity of partnership as a default rule, could alter the existing contractual rights of partners and third parties, we recommend that transitional provisions be included in the draft Bill to allow parties to consider their position and, if appropriate, to renegotiate their agreements.

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Note 1    RUPA was finalised by the National Conference of Commissioners on Uniform State Laws in 1994.    [Back]

Note 2    English and Scottish partnerships are governed by the same legislation, the 1890 Act.    [Back]

Note 3    They included the Association of Partnership Practitioners, the Institute of Chartered Accountants in England & Wales, the Association of Chartered and Certified Accountants, the Architecture and Surveying Institute, the Association of Consulting Actuaries, the Association of District Judges, the Construction Industry Council, the Institute of Directors, the City of Westminster Law Society and Holborn Law Societies, Clifford Chance LLP, Professor Geoffrey Morse and Roderick Banks. The Royal Institution of Chartered Surveyors and the British Bankers’ Association favoured the introduction of legal personality through the registered partnership.    [Back]

Note 4    They included the Chancery Bar Association and the Law Reform Committee of the Bar Council. The Law Society and Michael Twomey considered that legal personality was unnecessary.     [Back]

Note 5    See Part VIII below.    [Back]

Note 6    In 1855 the Mercantile Law Amendment Committee in their Second Report suggested that English law should adopt separate legal personality. Lord Lindley in his Supplement on the 1890 Act appears to have regretted a lost opportunity to make this innovation: Lindley & Banks, para 1-10.     [Back]

Note 7    The Construction Industry Council.    [Back]

Note 8    Quoted inLindley & Banks, para 3-02. Under our recommendations a creditor of a partnership can enforce a claim against the partners who are liable for that claim without first exhausting enforcement against the assets of the partnership. This contrasts with the approach in RUPA. See paras 7.51 and 7.53 below.    [Back]

Note 9    CPR, Sched 1, RSC O 81, r 1.    [Back]

Note 10    CPR, Sched 1, RSC O 81, r 5(1) provides “where a judgment is given or order made against a firm, execution to enforce the judgment or order may, subject to rule 6, issue against any property of the firm within the jurisdiction”.     [Back]

Note 11    Which is also followed in Scotland.    [Back]

Note 12    See the statement of the Inland Revenue quoted in para 3.53 above.    [Back]

Note 13    See the 1890 Act, ss 17(3) and 18.    [Back]

Note 14    We have referred to Michael Twomey on the drawbacks of the partnership at will (para 3.8 above) and to Lord Lindley’s support for separate legal personality (para 5.5, footnote 6).    [Back]

Note 15    Morse, Partnership Law (5th ed 2001) p 4.    [Back]

Note 16    We discuss the problems relating to property and contracts in paras 5.18 – 5.23 below.    [Back]

Note 17    Lindley & Banks, para 3-08.    [Back]

Note 18    Ibid, paras 3-09 – 3-16.    [Back]

Note 19    Higgins & Fletcher, The Law of Partnership in Australia & New Zealand (8th ed 2001) pp 11 – 12.    [Back]

Note 20    [1997] 2 BCLC 222.    [Back]

Note 21    Ibid at p 227 per Sir John Balcombe.    [Back]

Note 22    We discussed the contract “with the house” in the Joint Consultation Paper, paras 4.41 – 4.42 and identified the conceptual difficulty as to how the “new” partnership (or new partner) which had not entered into the contract was bound by it.     [Back]

Note 23    At the same time if a third party wishes to have a contractual relationship with a partnership only so long as the membership of that partnership does not change, he will be able to do so under our recommended scheme just as he can in the existing law.     [Back]

Note 24    The persons may no longer be members of the partnership when the claim is made. In our recommendations the date at which secondary liability is incurred in relation to a tort or delict is the date of the act or omission. See paras 6.79 – 6.80 below.     [Back]

Note 25    See our discussion of the liability of the incoming and outgoing partner in Part VI below. The incoming partner’s capital would be an asset of the continuing partnership and would thus be available to the creditor of the partnership. The new partner could also expose his personal assets indirectly if the continuing firm gives an indemnity to an outgoing partner in relation to the partnership’s obligations.     [Back]

Note 26    UPA 1914, s 17 and now RUPA 1994, s 306.    [Back]

Note 27    See Income Tax Commissioners for the City of London v Gibbs [1942] AC 402. See also Lord Lindley, quoted in Lindley & Banks at para 3-04, who states “The law, ignoring the firm, looks to the partners composing it; any change amongst them destroys the identity of the firm; what is called the property of the firm is their property, and what are called the debts and liabilities of the firm are their debts and their liabilities.”    [Back]

Note 28    Fairway Development Co v Title Insurance Co 621 F Supp 120 (ND Ohio 1985). This case influenced the drafters of RUPA to adopt a default rule of continuing legal personality.     [Back]

Note 29    See Part IX below. It has been suggested to us that a constructive trust would operate to allow the partnership property to be held for the new firm. Whether or not this is the case, there is scope to simplify the holding and transfer of partnership property.    [Back]

Note 30    It would also deal with the complications caused by a change in the partners which Lindley & Banks list in paras 3-08 to 3-16.    [Back]

Note 31    See para 12.82 below.    [Back]

Note 32    Hurst v Bryk is unreported at first instance (Carnwath J 11 April 1995); the Court of Appeal’s decision is reported in [1999] 1 Ch 1 and the House of Lords’ in [2002] 1 AC 185.     [Back]

Note 33    Lord Millett’s speech provided the reasons for the decision with which the other Law Lords concurred. The House of Lords did not decide the question whether an innocent partner’s acceptance of repudiatory breach automatically dissolved a partnership.    [Back]

Note 34    [2003] Ch 250.     [Back]

Note 35    See Part VIII below.    [Back]

Note 36    In Scots law, which does not have separate rules of equity, the duty of good faith as between the partners together with the contractual duties of the partners under the partnership agreement or in the implied contractual terms of the default code will enable the court to achieve similar results to those achieved in English law by application of the rules of equity.     [Back]

Note 37    We discuss in Part XI below the fiduciary duties of partners. Contractual doctrines such as mutuality of obligation and the fiduciary duties of the partners which enable the partners to regulate each other’s conduct where a partner is acting in breach of contract or in breach of his fiduciary duty will continue to apply. See para 8.123 below.    [Back]

Note 38    Vennootschap onder firma or VOF.    [Back]

Note 39    Openbare vennootschap.    [Back]

Note 40    In addition the Bill introduces the silent partnership or stille vennootschap. It has also been announced that the new partnerships will be transparent for the purposes of individual and company income tax.    [Back]

Note 41    The Limited Liability Partnerships Act 2000.    [Back]

Note 42    See Bromberg and Ribstein on Partnership para 1.03 “Partnership as a legal entity” (We are very grateful to Larry Ribstein for persuading his publishers to give us a free copy of this authoritative, four volume work on Partnership Law). The authors note that in Louisiana and Puerto Rico, which followed the civil law, partnerships were characterised as separate entities: para 1.03(b) n 3.     [Back]

Note 43    For a comparative historical treatment, see Deborah DeMott, “Transatlantic perspectives on Partnership Law: Risk and Instability”, Journal of Corporation Law loc cit pp 879, 882-3. She records that the draftsman of the 1914 Act took “particular authorial pride in having reduced, to 12 lines, the Partnership Act’s one-page treatment of when a recipient of a share in profits is not a partner.” (cf 1890 Act s 2)     [Back]

Note 44    Bromberg and Ribstein op cit para 1.03(b); see also De Mottop cit.    [Back]

Note 45    These and other issues raised by RUPA were discussed at a conference (attended by the then Chairman of the Law Commission) at Tillburg University, Holland, in May 2001: “International Conference on Close Corporation and Partnership Law Reform in Europe and the United States”. Some of the papers have been published in the Journal of Corporation Lawloc cit.     [Back]

Note 46    Weidner and Larson: The Revised Uniform Partnership Act: The Reporters’ Overview (1993) 49 The Business Lawyer p 1.    [Back]

Note 47    Ribstein has been a strong critic of other aspects of RUPA (notably its treatment of fiduciary duties): see eg Ribstein, “RUPA, not ready for prime time” (1993) 49 The Business Lawyer 45.    [Back]

Note 48    Bromberg and Ribstein op cit para 103(d). Prof Allan Vestal, another critic of RUPA (see eg “The mess we have made of partnership law” (1997) 54 Washington and Lee Law Review 487) has commented (in an email of 11/6/01, responding to the suggestion that the change to entity status had proved “relatively uncontroversial”): “Your reading of the reception given the adoption of the entity theory is quite correct. There has been little if any controversy about it, in part I suspect because various courts had years ago fashioned common law fixes for the worst implications of the aggregate theory. So the move to the entity theory did not change many aspects of how lawyers handle day to day problems.”    [Back]

Note 49    See Donald J Weidner “Pitfalls in Partnership Law Reform: Some United States Experience” [2001] Vol 26 Journal of Corporation Law, 1031.    [Back]

Note 50    The Law Society expressed concern that the exposure of the personal assets of an incoming partner to prior partnership liabilities might damage professional partnerships by deterring people from becoming partners. Our recommendation in para 6.80 below should avoid this mischief, at least in the default code.    [Back]

Note 51    Apart from those occasioned by the uncertainty about continuity of personality.    [Back]

Note 52    We refer here not to companies registered under the Companies Act 1985 but to the often ancient law of corporations: Halsbury’s Laws of England (Fourth edition Reissue Vol 9(2)).    [Back]

Note 53    See Major v Brodie [1998] STC 491, 510. The result would be that the partners in partnership A would not be partners in partnership B. Their involvement in carrying on the business of partnership B would be in their capacity as partners in partnership A. They would have secondary liability for partnership A’s obligations arising out of its status as a partner in partnership B.     [Back]

Note 54    See paras 4.41 – 4.42 above.    [Back]

Note 55    See Part XIV below.    [Back]

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You are here: BAILII >> Databases >> Scottish Law Commission >> Scottish Law Commission (Reports) >> Partnership Law [2003] SLC 192(5) (Report) (November 2003) URL: http://www.bailii.org/scot/other/SLC/Report/2003/192(5).html Cite as: [2003] SLC 192(5) (Report)