Flyover 4 - Partnership Dissolution

Welcome to the fourth agency and partnership flyover lesson. We're getting into partnership dissolution and some special rules for limited partnerships.

Partnership Dissolution

The Revised Uniform Partnership Act sets out a process for shutting down partnerships. Let's run through some key concepts.

Disassociation

A partner who decides to leave a partnership may disassociate from the partnership at any time. This essentially means that they have taken themselves out of the partner role. Whether the partnership itself will continue without that partner depends on the partnership agreement and whether the remaining partners want to continue. But for our purposes here, a partner disassociating from the partnership may or may not lead to dissolution of the partnership.

Rightful vs. Wrongful

Much depends on whether a partner's decision to disassociate from a partnership was rightful or wrongful. As a general rule, partners may freely disassociate from a partnership at will at any time. Partners may also wrongfully disassociate from partnerships. If a partner wrongfully disassociates, then the partner remains liable to the partnership for any damages caused by their disassociation.

Disassociation may be wrongful in a number of circumstances. If disassociation somehow breaches the partnership agreement, then it is wrongful. If it is a partnership for a particular undertaking, withdrawing before the completion of the particular undertaking will be wrongful.

Now, you may be wondering, what is a partnership for a particular undertaking? All that it means is that the partnership has a defined goal which is capable of being accomplished. For example, a partnership formed to renovate and sell a house would be a partnership for a particular undertaking. An open-ended partnership to simply make money would not be.

Dissolution

The term "dissolution" here refers to dissolving the partnership entity itself. If the partnership is dissolved, then the former partners may wind up the affairs of the partnership and terminate it. Of course, partners do not need to dissolve a partnership simply because one of the partners has decided to leave.

Buyouts

If a partner disassociates and the partnership elects to continue instead of dissolving and winding up its affairs, the partnership must purchase the disassociated partner's partnership interest. Many disputes revolve around how much a partner should be paid for that interest.

The rule is that the partnership purchase the interest for a price that is the largest of either (1) the disassociated partner's pro rata share of the liquidation value of the partnership, or (2) the disassociated partner's share of the value of the partnership business if it were sold as a going concern.

Partners who wrongfully disassociated are also entitled to buyouts. They receive the same buyout price less any damages caused by the departure.

Limited Partnerships

Limited partnerships operate a bit differently. A limited partner may only withdraw from a limited partnership on the terms set out in the partnership agreement. If there is no partnership agreement, or if it says nothing about withdrawal, a limited partner must give the general partners six months' written notice before withdrawing.

The limited partners in a limited partnership have very limited rights. The general partner manages the affairs of the partnership and has personal liability. Still, limited partners do have the right to inspect partnership records and obtain information from the general partner. At the least, the general partner must provide limited partners with tax returns for each year.

The model act here also specifies that limited partners may obtain any other information regarding the affairs of the limited partnership as is just and reasonable. Limited partners generally have the economic rights set out in the limited partnership agreement. If it says that a limited partner receives 15% of any profits, the limited partner will receive 15%.

If there is no provision in the limited partnership agreement, the default rule is that profits and losses shall be allocated on the basis of the value of the contributions made by each partner to the extent they have been received by the partnership and have not been returned.

Summary

For the MEE, you'll want to have some sense about how limited partnerships differ from general partnerships and limited liability partnerships. My expectation here, though, is that most questions will focus on general partnerships.

If you have a partner leaving a partnership, you should focus on a few things. First, did the partner do anything to compete with the partnership before disassociating? Those kinds of acts may be a breach of fiduciary duty. After the partner disassociates, you want to focus on whether it was a rightful or wrongful disassociation.

It may be important to look at why a partnership was formed. If it's open-ended, it's likely a rightful disassociation. If the partnership was formed for a particular business objective which has not yet been achieved, you have a wrongful disassociation.