Updated: Jul 15, 2020
By Jigar Desai
Due to the coronavirus, we are living in difficult times, and for many businesses, dissolution may be the best option right now. Dissolution of a business is one of the last steps of liquidation where the assets and property of the business are sold. We have provided a guide on how to dissolve a partnership. Why would a business owner decide to dissolve a partnership? Common reasons for dissolution are: low cash flow, partnership disagreements, business mismanagement, etc. Chron lists out the many reasons for dissolution. Once dissolution has completed, a partner’s liability and debt with the business has ended.
A general partnership is a business organization where each partner has unlimited liability and equity authority. It is a common type of business where there are multiple owners who share the profits, for example, two owners of a local ice cream shop. Under the Uniform Partnership Act, a partnership ends when one partner ends their association with the business. A common way that partner would dissociate with a business would be by voluntarily walking away from the business. However, dissociation does not officially dissolve the business. Dissociation leaves the option for the remaining partners to buy out the dissociated partners share of the business. The buyout leaves the business intact and able to move forward. The buyout amount would be the partner’s capital account if all the assets are sold and distributed to each partner.
To dissolve a partnership, an owner should first look to their partnership agreement. A majority of partnership agreements require a vote and a majority of voters to dissolve a partnership. It is recommended to record the votes and voting process for future need, such as evidence in a court or for tax purposes. There is no specific guideline on how to conduct this, so during the pandemic, partners may choose to conduct the voting through a video conference. Often, the partnership agreement will list out specific steps on how to dissolve the partnerships. For example, a dissolution clause in a partnership agreement may state that the business will operate for 20 years and then automatically terminate leaving all debts and profits to be divided equally. Even if a business does not have a written partnership agreement, it is not too late to create one. The US Chamber of Commerce lays out an easy way to create one. If there is no formal dissolution clause or partnership agreement, then the partners should get together to create and add the terms. A third-party, such as lawyers, may be needed if the owners cannot agree on terms of dissolution. A dissolution agreement with a termination provision should include ways to settle matters, such as obligations and debts.
When considering clauses to add to a partnership agreement to avoid possible difficulty when dissolving the business, add withdrawal, valuation and winding-up clauses. A withdrawal clause allows a partner to disassociate any time after a set time period into the partnership. A valuation clause sets out the process of how the business’s property will be evaluated for a partner’s buyout. Lastly, the wind-up clause sets out a third-party in the agreement to conduct the wind-up process for the business. For example, the clause can state that, rather than selling the property and giving cash to the partners, the third-party allocates the property in kind to each partner.
Once the vote or decision has been made to dissolve the business, the winding-up process begins. The winding-up steps include: 1) completing any works in progress, 2) selling assets, 3) paying off debts, and 4) distributing remaining assets to partners. Both creditors and partners can petition for a claim during the winding-up process. When creditors can petition during a winding- up process, they are seeking to collect a debt that the partners owed them. If the partners cannot fulfill their debts owed to creditors, they can negotiate a long-term payment plan or debt relief. On the other hand, a partner’s petition for winding up can only be done when there is no bankruptcy pending. Only partners that currently remain with the partnership have the right to the assets. This means that partners who have left before have no claim during the winding-up process.
Property of a partnership is usually held equally between partners, meaning that partners would have an equal share of the profit coming from its sale. As the property is restricted only to property that belongs to the partnership purposes only, this can cause some dispute between partners as to what will be considered property of the partnership. A partnership agreement would clearly define what is partnership property. Again, a third-party may be required if there is no written partnership agreement. After the sale of the partnership property, the profit from the sale will be paid off to creditors first. The surplus cash will then be given to partners, then to partners for capital, and then to partners for profits. Most commonly, partners who have contributed capital into the business will receive their initial capital input back.
The remaining steps of the winding-up process is to close out the business’ bank account and pay the remaining taxes owed. A state will not allow a business to officially dissolve without paying all the taxes paid. Partners should save any tax documents as proof for the state tax department. Partners should cancel registrations, permits, and licenses associated with the business. These are typically state and local business licenses. Some licenses are acquired under a trade name and also need to be canceled. Intellectual property is similar to property in this sense. Although intellectual property can be freely surrendered like licenses, they are often sold like property and split up by partners. Intellectual property can be assigned to specific partners based on the partnership agreement as well.
The next step is to file a dissolution document with a state agency and the requirements will vary between states. These documents are commonly referred to as the articles of dissolution. A partner will have to fill out a form online to notify the Secretary of State, which will depend on the state the business is located in. An example is the California’s Secretary of State’s website where a partner can download their dissolution documents here. Each state has its own procedure for filing the articles of dissolution. Remember that the location of your business will determine which state’s procedure will apply.
Once these steps are completed, then the business will be terminated and partners will be protected from future liability due to the dissolution.
As mentioned above, the dissolution of a partnership requires a majority or all of the partners to vote in favor of one. When partners cannot agree on voluntarily closing the business or buying out a partner, judicial dissolution is involved. A partner must show a court that: 1) the purpose of the partnership is likely to be unreasonably frustrated, (2) another partner has engaged in conduct making it not reasonably practicable to carry on the business of the partnership, or (3) it is otherwise not reasonably practicable to carry on the business in conformity with the partnership agreement. Samuel Goldman & Associates describes this showing here.
In addition to proving one of the grounds for dissolution, the partner seeking dissolution must also show that the partnership was harmed or in danger of being harmed economically. It is very helpful to have a partnership agreement to compare the difference between expectations and actual results to show why dissolution is necessary. The right to a judicial dissolution cannot be eliminated by partnership agreement. A few examples that call for a judicial dissolution are: a partner is taking part in illegal activities, a partner is not fulfilling their agreement in the business, or the partner is not adequately funded to invest in the business. This may be a wise decision for a business to make, as partners share liability with each other. This could be a scenario where a partner is engaging in illegal activity through the business. The remaining partners can seek judicial dissolution out of fear of the business being forced to closed down. The wrongful actions of a partner can bring liability and can close down the business. Partners who are seeking judicial dissolution are essentially forcing the wrongful partner out and continuing a business amongst themselves. An example is a group partner, who operated an apartment complex, but one of the partners used the apartment for illicit activity. The partner who sought out judicial dissolution can still operate together, but without the liability of the wrongful partner.
A limited partnership is another type of relationship, in which one partner is not involved in the day-to-day management of the business. The limited partner serves like an investor to the business, bringing in capital without management control. The lack of control over the business gives the limited liability to the limited partner. This means that the limited partner’s personal assets cannot be reached by creditors to pay off debts. The limited partner cannot conduct any activities with regard to the business without partnership approval, such as withdrawing their capital. Harvard Business Services, Inc. describes the difference between a general and limited partnership here.
The dissociation process for a limited partner is similar to that of a general partner. A key difference between the general and limited partnership is that the limited partner cannot dissociate until after the wind-up process. In comparison, the first step in dissolving a general partnership is for the partner to disassociate from the business before winding up. For a limited partner, the dissociation is the last step. However, a limited partner requires a majority vote of all partners and the general partner’s approval to disassociate. A limited partner also cannot bring a suit to dissolve a partnership because of a general partner’s actions.
Limited Liability Partnership (LLP)
Another form of creating a business is through a limited liability partnership. Under a general partnership, two or more people come together to create a business but do not create a separate business entity. LLPs experience the most protection against liability from the actions of other partners and employees. Since an LLP is only formed only by a partnership agreement, there will most likely be a defined procedure on how to dissolve the LLP. A key difference to an LLP is that only general partners can vote on dissolution, but not limited partners. For more information on LLPs, click here.
Dissolution of a business can be seen as a failure, which can cause additional grief during these trying times. However, a dissolution allows a partner to sever ties from a business venture that may be failing, and start clean with another future opportunity. When a dissolution is done properly, it can save a partner money and future liability. As one door closes today, another one opens tomorrow.
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