Introduction to Forms of Business and Formation of Partnerships

Operation of Partnerships and Related Forms

Partners’ Dissociation & Partnerships’ Dissolution and Winding Up

Limited Liability Companies, Limited Partnerships, and

Limited Liability Limited Partnerships

© 2010 The McGraw-Hill Companies, Inc. All rights reserved.

Partnerships’ Dissociation and Partnerships’ Dissolution and

Winding Up

Change is inevitable, but it is in us to control its content and directions.

Indira Ghandhi , Indian Prime Minister, speech (Jan. 8, 1967)

© 2010 The McGraw-Hill Companies, Inc. All rights reserved.

Learning Objectives

v Dissociationv Dissolution and winding up the

partnership business v When the business is continuedv Partners joining an existing partnership

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v Sometimes even the best-laid plans go awry and a business fails

v Sometimes, it’s just time to make a change, modifying a partnership business to re-emerge as another partnership form, a Limited Liability Company, or a corporation

v Whether an ending or new beginning, this chapter is about controlling a change in direction

Overview

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v The Revised Uniform Partnership Act (RUPA) defines dissociation as a change in the relation of partners caused by any partner ceasing to be associated in the carrying on of the business:wA partner’s retirement, death, or expulsionwA bankruptcy filing

Dissociation

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v Dissociation starts the process of dissolution, winding up (liquidation), and termination of a partnership

v A partner has the power – but not necessarily the right – to dissociate from the partnership at any time, such as by withdrawing from the partnershipw A partnership agreement may provide for a right

of dissociation

Dissociation

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v Nonwrongful dissociation does not violate a partnership agreement and includes events such as the death or retirement of a partner, or partner’s withdrawal in accordance with partnership agreement

Nonwrongful Dissociation

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1. Withdrawal of a partner that breaches an express provision of partnership agreement

2. Withdrawal of a partner before the end of the partnership’s term or completion of its undertakingw Unless partner withdraws within 90 days after

another partner’s death, adjudicated incapacity, appointment of custodian over his property, or wrongful dissociation

Wrongful Dissociation

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3. A partner’s filing a bankruptcy petition or being a debtor in bankruptcy

4. Judicial expulsion of a partner by request of the partnership or another partner based on:w Partner’s wrongful conduct that adversely affects

partnership businessw Partner’s wilfull and persistent breach of fiduciary

duties or the partnership agreementw Partner’s conduct makes it unreasonable to conduct

partnership business with the partner

Wrongful Dissociation

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v Acts not causing dissociation include:w Partner’s transfer of transferable partnership

interestw Creditor obtaining a charging orderw Adding a partner w Disagreements between partners

v Partners may limit or expand the definition of dissociation and events considered wrongful or nonwrongful

Other Events & The Agreement

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v When a partner dissociates, dissolution may be the next step, but RUPA allows the partnership business to continue after a partner’s dissociationw Thus dissolution is not

automatic

After Dissociation

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v RUPA provides a list of events that force a partnership to be dissolved and wound up

v May be altered by agreementwSchwartz v. Family Dental Group,

P.C. : court interpreted the partnership agreement to allow two dental partners to expel a third partner from partnership without cause

Dissolution

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v Dissolution begins the winding up process:w Orderly liquidation of the partnership assets and

the distribution of the proceeds to those having claims against the partnership

v Winding up partner has implied authority to do those acts appropriate for winding up the partnership business and apparent authority to conduct business as s/he did before dissolution

Dissolution

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v To eliminate apparent authority of winding up partner to conduct business in ordinary way, the partnership must ensure one or more of these occur:

1. Third party knows or has reason to know partnership has been dissolved

Dissolution & Apparent Authority

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2. Third party received dissolution notification by delivery of communication to third party’s place of business

3. Dissolution has come to the attention of the third party

4. A partner filed a Statement of Dissolution with the secretary of state limiting the partners’ authority during winding up

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Dissolution & Apparent Authority

v Facts:w Partnership owned racehorse; a disagreement

arose related to veterinary care and trainingw Two partners (plaintiffs) notified partner Crane

they were dissolving the partnership and directed Crane to deliver horse to a trainer

w Crane refused to relinquish control and plaintiffs sued, requesting court to appoint a receiver to continue racing the horse and then sell the horse; Crane objected

Paciaroni v. Crane

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v Legal Reasoning and Conclusion:w Once dissolution occurs, the partnership

continues only to the extent necessary to complete transactions begun but not finished.

w The partnership’s business purpose was to race the horse, thus “the winding up of the partnership affairs should include the right to race” the horse

w The court also established some conditions.

Paciaroni v. Crane

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v After partnership assets have been sold during winding up, proceeds are distributed to those who have claims against the partnershipw Includes partners, but

creditor claims satisfied first

Winding Up and Distribution of Assets

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v Remaining proceeds from sale of assets will be distributed to the partners according to the net amounts in their capital accounts w Partner’s capital account is credited (increased)

for capital contributions partner made to partnership plus partner’s share of profits

w Partner’s capital account is charged (decreased) for partner’s share of partnership losses

Distribution of Assets

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v Asset distribution rules modified for limited liability partnership since in an LLP most partners have no liability for partnership obligations

v If a partner committed malpractice or another wrong for which LLP statutes do not provide liability protection, the partner must contribute funds to the partnership

Distribution of Assets For an LLP

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v After partnership assets have been distributed, termination of the partnership occurs automatically

Termination

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v Partners may choose not to seek dissolution and winding up after dissociation

v When the business of a partnership is continued, creditors of the partnership continue as creditors of the person or partnership continuing the business.

v Original partners remain liable for obligations incurred prior to dissociationw Including dissociated partners

If Business Continued

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v In bankruptcy proceeding of partnership, dissociated partners argued they were not liable for partnership obligations

vCourt considered UPA and RUPA rules and concluded that dissociated partners had neither notified creditors of dissociation nor obtained by agreement with partnership any discharge of liabilities

In re Labrum & Doak

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v When partnership continues, partnership is required to purchase dissociated partner’s partnership interest

v Partnership agreement may specify how to value the partnership or RUPA rules the amount and timing of a buyout of dissociated partner’s interestwSee Warnick v. Warnick

Buyout

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v A partnership agreement generally states terms under which a new partner is admitted to a partnership

v In absence of a partnership agreement, RUPA sets rules for partner’s admission and rights and duties upon admission:w New partner fully liable for all partnership

obligations incurred after admission as partner, but no liability for obligations incurred before admission as partner

Partners Joining Partnership

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v RUPA states that a new partner in an LLP incurs no liability for any LLP obligations, whether incurred before or after admission, beyond new partner’s capital contribution unless new partner committed malpractice or other wrong (and incurs personal liability)

Partners Joining LLP

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Test Your Knowledge

v True=A, False = Bw Dissociation is the orderly liquidation of the

partnership assets and the distribution of the proceeds to those having claims against the partnership.

w When a partner dissociates, dissolution is the required next step.

w Winding up is a change in the relation of partners caused by any partner ceasing to be associated in the carrying on of the business.

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Test Your Knowledge

v True=A, False = Bw In winding up, remaining proceeds from the

sale of assets will be distributed to the partners according to the net amounts in their capital accounts

w Winding up partners have apparent authority to conduct business as they did before dissolution

w When a partnership continues, the partnership must purchase the dissociated partner’s partnership interest

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Test Your Knowledge

v Multiple Choicew James was a partner in a three-person law

partnership without a partnership agreement. Medical bills forced James to file for personal bankruptcy. James has:

(a) Engaged in wrongful dissociation

(b) Engaged in nonwrongful dissociation

(c) Engaged in wrongful dissolution

(d) Engaged in nonwrongful dissolution

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Test Your Knowledge

v Multiple ChoicewGreg, Pat, and Oprah were partners in a

music store. Greg transferred his transferable partnership interest to his nephew. Greg:

(a) Engaged in wrongful dissociation

(b) Has exercised a partnership right

(c) Engaged in nonwrongful dissociation

(d) None of the above

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Thought Questions

v How would you deal with a partner who was mismanaging the firm or committed malpractice? How would you deal with a partner who had a substance abuse problem?

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