978-0077733711 Chapter 39 Lecture Note

subject Type Homework Help
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subject Authors A. James Barnes, Arlen Langvardt, Jamie Darin Prenkert, Jane Mallor, Martin A. McCrory

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Chapter 39 - Partners' Dissociation and Partnerships' Dissolution and Winding Up
CHAPTER 39
PARTNERS' DISSOCIATION AND PARTNERSHIPS'
DISSOLUTION AND WINDING UP
I. OBJECTIVES
This chapter is intended to acquaint student with the process by which partners leave and enter
partnerships. A student should be able to:
A. Define dissociation and distinguish wrongful dissociation from nonwrongful dissociation.
B. Understand the consequences of wrongful and nonwrongful dissociations.
C. Know the causes of dissolution.
D. Know the powers of partners during winding up.
E. Understand how assets are distributed during winding up.
F. Know the liability of partners who dissociate from a partnership and the liability of partners
who join an existing partnership.
G. Learn how to write a partnership agreement that modifies the default rules of the RUPA to
meet the needs of the partners.
II. ANSWER TO INTRODUCTORY PROBLEM
A. The default rules are long and complex, so we refer you to the textbook. A good summary of
some aspects of the rules is in the Concept Review on page 1043. It is possible to expand
that summary to include other events, such as transfers of transferable interests and partner
bankruptcies. The outline can include more information, such as details on valuing a
partnership interest and the procedures during the winding up process.
B. There are several objections to the default rules, but here are a few important ones in a
partnership for a term. If a partner dies, a vote of only 50% of the partners can dissolve the
partnership and wind up the business. While this is a good rule if the deceased partner was
important to the partnership’s success, this can be bad also, because the business may be
worth more as a going concern. If a partner dies, any other partner may dissociate and do so
nonwrongfully. While this rule protects a partner who thinks her risks have increased due to
the death of the partner (who may have been a mentor, friend, valuable manager, or
rainmaker), the rule may result in a drain on partnership capital and talent. The risks are a bit
different if a partner retires, because the retiring partner may be able to take clients with her,
making continuation of the business less desirable. The method of valuating a partners
partnership interest is good because it reflects true value, but it is bad because it doesn’t state
a definite, concrete valuation methodology. Thus, if partners can’t agree on the valuation
method, a court will value the partnership interest, which introduces significant risks, because
most judges have no financial education, no financial experience, and no business making a
financial decision for our partnership. The timing of the payment for the value of the
partners interest is also troubling, as it may be too long in some cases (when the partnership
dissolves, unless there is no hardship) and too quick in others (120 days after a written
demand for payment).
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Chapter 39 - Partners' Dissociation and Partnerships' Dissolution and Winding Up
C. A well written partnership agreement should have a section dealing with partners’ leaving and
entering the partnership. For partners leaving the partnership, it should include the following
subsections: 1) Causes of partners’ dissociation, including automatic dissociations such as by
death, judicial dissociations, and dissociation by vote of the partners (including the procedure
by which partners act); 2) the effect of dissociation on the partnership, including when the
partnership continues and when it dissolves (such as automatic and judicial dissolutions and
dissolution by vote of the partners); 3) the effect of dissolution on the rights of other partners,
such as the right of selected partners (perhaps a founding partner) to dissociate if a friend or
other founding partner dies or retires; 4) the powers of the partners during winding up,
including who may wind up the business; 5) the buy-out of dissociated partners, including the
valuation methods and allowable deductions against the partnership interest; 6) the timing
and financing of the buy-out of a partner, including whether in a lump sum or installments
and whether financed by a life insurance policy, an annuity, or otherwise; 7) the effect of
dissociation on a partners management authority, including the duties to notify partnership
creditors of the dissociation; 8) the dissociated partners liability for competing with the
partnership after dissociation; 9) the dissociated partners liability for partnership obligations,
including the dissociated partners duty to disclose material facts and the partnership’s
agreement to indemnify the dissociated partner. For partners entering the partnership, the
agreement should including the procedure for admitting new partners, including eligibility
rules, terms of admission, and process for partners’ approval of the terms of admission. The
terms of admission should include the new partners capital contribution obligation, share of
partnership losses, and liability for partnership obligations incurred before he became a
partner. The terms of admission also may contain the new partners compensation and
management power or merely refer to those sections of the partnership agreement. Figure 3
on page 1109 in Chapter 42 of the corporation law material may be referred to for suggestions
in writing a buyout agreement not only among shareholders in a corporation, but also
partners in a partnership.
III. SUGGESTIONS FOR LECTURE PREPARATION
A. Introduction
Briefly define and distinguish dissociation, dissolution, winding up, and termination. Note
that neither dissociation nor dissolution terminates the partnership. The partnership remains
in existence until winding up has ended and termination of the partnership occurs. Note that
dissociation of a partner may lead down either of two paths: dissolution and liquidation of
the assets or continuation of the business.
B. Dissociation and Dissolution
1. Define dissociation and wrongful and nonwrongful dissociations. Define dissolution.
Note what types of dissociation cause dissolution and which ones grant an option to the
partners to dissolve the partnership.
a. Stress that dissociation results from a partner ceasing to be associated in carrying on
the business.
Example: Problem Case # 2.
b. Point out that dissolution is the start of the winding up process and will follow some
dissociations automatically and other dissociations by choice of the partners.
c. Point out the nonwrongful dissociations on page 1029. Note that a partner has the
power and the right to dissociate from a partnership in these ways. Stress the
consequences of nonwrongful dissociation.
Examples:
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Chapter 39 - Partners' Dissociation and Partnerships' Dissolution and Winding Up
1) Ann retires from a partnership with no term. This is nonwrongful, since the
partnership is at-will. Ann’s dissociation also dissolves the partnership. The
business will be wound up unless all partners including Ann agree not to wind up
the business.
2) Ann retires at age 65 from a partnership with a term expiring in 2027. The
partnership agreement permits partners to retire after reaching age 65. The
dissociation is nonwrongful. The partnership is not dissolved automatically, but
may be dissolved only by unanimous agreement of the partners or in accordance
with the partnership agreement.
3) In a partnership with a term expiring in 2027, Ann assigns her partnership interest
to her personal creditors. There is no dissociation. However, her partners may
expel her from the partnership, causing a nonwrongful dissociation. No
dissolution occurs unless the remaining partners decide unanimously to dissolve
the partnership.
c. Note that wrongful dissociations breach the partnership agreement, are caused by a
partners being in a bankruptcy proceeding, or are ordered by a court due to a
partner's breach of his fiduciary duty. Note that a partner has the power but not the
right to dissociate from a partnership in these ways. Stress to your students the
consequences of wrongful dissociation (p. 1030).
Meyer v. Christie (p. 1031): The court found that the joint venture was not at-will,
but instead had been formed to complete a residential development project. The joint
venture’s term, therefore, did not terminate until the project was completed. By
leaving the venture prior to completion of its objective, Christie and Glenn
wrongfully dissociated.
Point for Discussion: Note that the court awarded damages of lost profits to Meyer
and Pratt. The court did not think profits were speculative, despite Christie and
Glenn’s having left the joint venture before the acquisition of the land or the
construction of any buildings on the land. In fact, the court cited concrete evidence
of the profits that the development might have generated: the profits generated from
the second venture that Christie and Glenn created to develop the land, which
development was generally the same as the development contemplated by the first
venture. In essence, Christie and Glenn stole the business idea from the first joint
venture and were found liable to the other partners in that venture for the portion of
the second venture’s profits that should have gone to Meyer and Pratt.
Additional Examples:
1) Abe leaves a partnership before its 30-year term expires. This is a wrongful
dissociation. The partnership will not be dissolved unless the partnership
agreement provides otherwise or a majority of the remaining partners vote for
dissolution. However, that wrongful dissociation allows any other partner to
dissociate within 90 days; that second dissociation would be nonwrongful.
2) Abe steals $1,000 from the partnership, which leads to judicial dissolution. This
is a wrongful dissociation for the stealing partner.
3) Abe refuses to take part in the management of the partnership business, which
leads to judicial dissociation. This is a wrongful dissociation and is grounds for a
judicial dissolution.
4) Problem Case # 1.
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manner. This document may not be copied, scanned, duplicated, forwarded, distributed, or posted on a website, in whole or part.
Chapter 39 - Partners' Dissociation and Partnerships' Dissolution and Winding Up
d. Point out the acts that may appear to cause dissociation or dissolution, but do not,
including transferring a transferable interest, suffering a charging order against a
partnership interest, adding partners, and partners’ being deadlocked.
2. Schwartz v. Family Dental Group, P.C. (p. 1033): The court found that the
partnership agreement permitted two partners to vote to expel the third partner.
Points for Discussion: Ask you students whether they think the three partners
really thought when they formed the partnership that one of them could be expelled by
the vote of the other two. We seriously doubt that was the intent, especially in a
partnership like this in which the partners are basically equal. Do your students think the
appellate court erred by interpreting section 9(a) of the partnership agreement to apply to
expulsion of a partner? Is expelling a partner “concerning the conduct of Partnership
business”? It is not really the conduct of business, is it?
Additional Point for Discussion: This is another good example of a poorly
drafted partnership agreement. Probably what the partners wanted section 9(a) to state
was that a majority of the partners could decided issues in the “ordinary” course of
business, which would not include expelling a partner. They also should have had a
comprehensive section that left no doubt about the only ways, if any, a partner could be
expelled.
Additional Example: Problem Case #3.
3. The Global Business Environment (p. 1039): Note that while partnership law in countries
other than the U.S. is more nearly like the UPA, it will not be surprising if foreign
countries adopt laws similar to the RUPA. Other countries watch carefully American
laws regarding business forms. Those countries often adopt and adapt American law.
C. Winding Up
1. Fiduciary Duties during Winding Up.
Note that fiduciary duties continue during winding up.
2. Compensation of Winding Up Partner.
The RUPA changes the UPA rule and requires the payment of reasonable compensation to
a partner who is winding up the business of the partnership.
3. Authority of Winding Up Partner.
a. Express authority. The partners may unanimously agree to confer any authority on
the winding up partner.
b. Implied authority
1) To engage in any transaction necessary to a liquidation of the assets.
Examples:
a) Hiring an auctioneer to auction the assets of the partnership.
b) Contracting to sell the partnership to a business in the same field.
2) To preserve assets and to enhance them for sale.
Paciaroni v. Crane (p. 1036). This case is cited in the comments to the RUPA as
the classic case in which business can continue during the winding up process.
The court held that the majority partners are permitted to race Black Ace, the
partnership's most valuable asset.
Points for Discussion: Ask your class why the court permitted the racing of
Black Ace during winding up. Racing him in the season's remaining stakes races
would preserve and enhance the value of Black Ace. Ask the class who should
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Chapter 39 - Partners' Dissociation and Partnerships' Dissolution and Winding Up
be allowed to train Black Ace due to the dispute between the partners concerning
who should train him. Note that the court said that a majority of the partners
controls the decision. The court, however, required the majority partners to post
a bond if they wish to continue to race Black Ace.
3) To complete executory contracts. Under this authority, a partner is able to
liquidate assets--by selling goods pursuant to a contract--and to preserve
assets--by avoiding liability for breach of contract.
Example: A bicycle manufacturer has a partially completed contract to
manufacture 500 bicycles for a national retailer. The winding up partner would
be permitted to order additional parts and to hire employees to complete the
contract.
4) To borrow money to do any of the above.
c. Apparent authority. Appropriate notice of dissolution must be given. Otherwise,
persons who extended credit to the partnership or who knew of the partnership will
believe that the business is being continued and that, therefore, any partner may do
what she did prior to dissolution. Note that the notification requirements to eliminate
apparent authority provide greater protection for third parties who have not
previously done business with the partnership than agency law. Note that the best
protection against third parties who are not given individual notice is the filing of the
Statement of Dissolution, which eliminates all apparent authority to conduct business
in the usual way after 90 days have passed.
Example: Dizzo Company, a partnership operating a retail toy store, is dissolved.
Notice of the dissolution is published in a newspaper in the locality in which the
partnership and its creditors and customers do business. Abe, a partner, contracts on
behalf of Dizzo to buy a new shipment of toys from Apex Toy Company, which did
not read the notice. Apex has previously extended credit to Dizzo. Dizzo is liable on
the contract for having failed to give Apex personal notice of the dissolution. Abe is
liable to his partners for having exceeded his actual authority. If Apex had not
previously done business with Dizzo but knew of Dizzo’s existence, Dizzo would
nonetheless be liable to Apex. Publishing notice in the newspaper was not enough,
because the creditor must know or have reason to know of the dissolution. This puts
the burden on the partnership to let third parties know the partnership has been
dissolved.
4. Distribution of Assets
a. List the order of distribution of partnership assets. Note that partners who are
creditors are paid pro rata along with other creditors. Payments to partner-creditors
may be temporary when a partnership is insolvent, because a partner may be asked to
contribute to pay all the unpaid claims of creditors.
b. Example: Problem Case #9.
D. Continuation of Business
1. Note again here that winding up need not always follow dissociation. For example, the
partners may merely fail to choose to wind up, in which case the business will continue
as before. After dissociation, often partners make a well considered choice whether to
dissolve and wind up the partnership or whether to continue the business.
2. Liability of Successor. Note that when the business of the partnership is
continued--whether by another partnership, by a sole proprietorship, or by a
corporation--the successor has liability for the debts of the business even though it has
not agreed to take over liability.
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Chapter 39 - Partners' Dissociation and Partnerships' Dissolution and Winding Up
3. Dissociated or Outgoing Partner Liability. The text states the liability of dissociated
(outgoing) partners for obligations prior to and after her withdrawal from the partnership.
Note that the notice requirement to escape liability for future obligations (that is, to avoid
purported partnership) are similar to the notice requirement to eliminate the apparent
authority of partners to carry on the usual business of the partnership after dissolution.
The easy cases are when the creditor expressly agrees to release the outgoing partner or
when the creditor has no reason to know the partner has left the partnership.
Additional Examples: Problem Cases #5 and 6.
4. Buyout of Dissociated Partners. Providing an appropriate buyout price for partners who
dissociate from the partnership (such as by retirement or death, or even if partners can’t
get along) is essential to avoiding litigation, preventing legal distractions for the
continuing partners, and ensuring that the partnership will continue without financial
strain. Note the default rule for the amount and timing of payment for the dissociated
partners share of the partnership. Stress to your students the need for well-planned
partnerships (indeed any business) to have a succession plan with a buyout arrangement
that is good for the partners who leave and the partners who remain.
Dixon v. Crawford, McGilliard, Peterson & Yelish (p. 1040). The court determined that
the dissociated partner was entitled to his share of the going concern value of the
partnership business without the dissociated partner. Thus, it was appropriate to include
goodwill in valuing the partnership’s remaining business, that is, the business absent the
clients the partner took with him.
Points for Discussion: Both the dissociating partner and the partnership presented
testimony from expert witnesses regarding valuation of the business. The court had to
decide which valuation to accept and how much of it to accept. Why did the parties need
to go to court to resolve the valuation issue? BECAUSE THEY HAD NO
PARTNERSHIP AGREEMENT. Here we have lawyers in a law partnership, and even
they are so foolish as not to have a written partnership agreement. That is pathetic. That
is one of the main points of this case. A partnership should have a well-constructed
partnership agreement, including a section on the buyout of partners, including the
amount and timing of the payments.
Additional Points for Discussion: What should the partners’ agreement have been
included regarding the buyout price? The partners can do whatever they want, although
it should be clearly articulated and able to be administered without disagreement. It is
common in a professional partnership merely to return to a dissociated partner the
amount in the partners capital account, reflecting her capital contribution and any share
of profits not yet distributed to her. This is administratively simple, avoids conflict and
litigation, and reflects the sentiment that partners are to make a profit while they are
working, not by receiving a capital gain on their investment in the partnership. Some
professional partnerships add to the amount in the capital account a portion of accounts
receivable, on the grounds that the uncollected accounts have not yet been recognized as
profits in a business that usually is cash basis (not accrual). Of course, since not all
accounts receivable are collected, they should be discounted in accordance with an
historical collection rate. Moreover, if profits are distributed to each partner in all or in
part in relation to the income produced by a partners clients, only the accounts
receivable attributable to a dissociated partners clients should be considered.
a. Additional Examples: Problem Cases ## 4, 7, 8, and 9.
b. Ethics in Action (p. 1044): The default rule for valuing partnership interests does not
state a valuation methodology such as discounted cash flows or a multiple of
earnings. Thus the default rule introduces ambiguity that fosters disputes and
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manner. This document may not be copied, scanned, duplicated, forwarded, distributed, or posted on a website, in whole or part.
Chapter 39 - Partners' Dissociation and Partnerships' Dissolution and Winding Up
litigation. If there is litigation, a judge who knows little about business valuations
may make the valuation decision.
The rationale for the default rule’s delaying the buyout of a wrongfully dissociating
partner until the partnership terminates reflects the partners’ expectations that they
will not have to buy out a partner until the partner dies or otherwise dissociates
rightfully. To make the partnership liquidate assets that are gainfully invested is a
hardship on the remaining partners. The default rule, therefore, is justified under
profit maximization, utilitarianism, and the categorical imperative. Its ethical basis
crumbles a bit when the partnership suffers no hardship in paying the wrongfully
dissociating partners earlier, which is why the default rule has that exception.
Nonetheless, as the answer to the Chapter Introductory Problem indicates, a well
planned partnership should have a section that delineates when a partner who
dissociates is paid and how much she is paid. Students should be asked to suggest
solutions for each of the events listed in the ethics problem. They should be asked to
evaluate their solutions by responding to several questions. What behavior will your
proposed rule encourage? Will the rule benefit you? Does it affect you differently if
you are the dissociating partner or the buying partner? Are you willing to accept the
consequences that the rule will foster? Such questions will help students consider the
ethics of the rule under profit maximization, the categorical imperative, and justice
theory.
5. Incoming Partner Liability.
a. Ask students why it is appropriate not to make incoming partners liable for at least
the amount of partnership assets, which is the UPA rule. The UPA rule seemed to
make sense because partnership assets are the minimum benefit partners receive by
being partners: they have the right to control the assets of the partnership.
Nonetheless, requiring such liability was a hollow gesture, because it really meant
that incoming partners had no liability. Once the partnership assets were exhausted,
the new partners could not be forced to pay unpaid creditors.
b. You may wish to explain more carefully why a partnership and a new partner may
agree that a new partner will assume full liability for all partnership debts, even
those incurred before she became a partner. Explain it this way: if
PricewaterhouseCoopers offers to one of your students partnership status and an
annual draw of $250,000 in return for assuming full liability, would your student
accept the offer of partnership? Of course she would. Fortunately for them,
however, PWC and other accounting and consulting firms are usually LLPs today,
meaning that new partners receive all the benefits of partnership but have liability
limited to their capital contributions. LLPs do not and should not require any of
their partners to assume full liability on partnership debts.
c. Examples: Problem Case # 10.
E. Partnership Agreements Modifying the Default RUPA Rules
1. It is important that partners not accept all the default rules of the RUPA as immutable
rules. As was discussed in Chapter 38, partners may modify the default rules to meet their
needs.
2. Example: Chapter Introductory Problem (p. 1028): This problem will help your students
understand the good and bad of the default rules and find better solutions to partnership
problems than the default rules provide. We like to approach a problem like this by
throwing out a scenario (such as a partner dying in partnership with a term), covering the
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manner. This document may not be copied, scanned, duplicated, forwarded, distributed, or posted on a website, in whole or part.
Chapter 39 - Partners' Dissociation and Partnerships' Dissolution and Winding Up
default rules regarding dissociation, dissolution, and buyout of the deceased partner,
asking students what is good and bad about those rules, and then suggesting better
solutions that can be included in the partnership agreement.
3. The Concept Review on page 1043 can provide a framework for analyzing the Chapter
Introductory Problem.
4. Log On (p. 1042): The RUPA is not only a source of law, but also a source of content for
the partnership agreement. Many partnership agreements parrot the content of the RUPA.
It is better to use the RUPA as a foundation and to modify it to meet the partners’ needs.
IV. RECOMMENDED REFERENCES
See the references in Instructor's Manual Chapter 37.
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manner. This document may not be copied, scanned, duplicated, forwarded, distributed, or posted on a website, in whole or part.

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