April 23rd, 2023
April 23rd, 2023
A partnership is one of the most common forms of business because it is a simple and inexpensive way to create a business structure. However, even in the best of circumstances, partners can find themselves dealing with unanticipated issues that require them to terminate the partnership, known as dissolution or dissolving, or for one of the partners to withdraw from the partnership itself.
There are many reasons why business partners may decide to end their business, such as the business not being successful, wanting to pursue a new venture, or trying to retire from work entirely. Failing to plan for these critical issues at the outset when first deciding to go into business together can create costly and unnecessary conflict among the partners. Just as important as deciding how the partnership will run is the partners deciding what will happen if one or all of them decide to withdraw or end the partnership.
This guide will walk through how partnerships can be dissolved and common issues that arise when a partner looks to withdraw from a partnership. By planning for these inevitable contingencies, partners can ensure a smooth and orderly transition.
For more information about the ins and outs of partnerships, please consult the guide Frequently Asked Questions about Business Partnerships.
There are many common situations why a partner would need to withdraw from a partnership including illness, death, retirement, divorce, or bankruptcy. If a partner would like to withdraw from their partnership, there are several steps they must take in that process after the withdrawing partner provides notice to the partnership using a Notice of Withdrawal from Partnership form.
Though it is not required, most business partners enter into a written agreement known as a Partnership Agreement that dictates the parties' rights and responsibilities, including what will happen if one of the parties wishes to leave the business. Partnerships are given a great deal of freedom by the law to establish their own rules guiding how they would like to operate their partnership. In almost all circumstances, partners can agree to their own terms governing their relationship and the partnership, even if these guidelines are different than state law. State statutes governing partnerships then work to fill in any gaps where the partnership agreement is silent or insufficiently clear, providing default rules that address these issues. So, the terms of the partnership agreement are the first stop when it comes to figuring out what will happen if one partner decides to withdraw from the partnership.
Most partnership agreements include provisions that cover the basic issues that arise when a partner decides to leave a partnership, such as:
Many partnerships also have what is known as a "buy-sell" clause in the partnership agreement or a standalone Buy-Sell Agreement. A buy-sell clause, or buy-sell agreement, stipulates how a partner's share of the partnership may be reassigned if that partner leaves the business for some reason. Most often, the buy-sell clause stipulates that the available shares must be sold to the remaining members of the partnership. They may also establish a method for determining the value of the business.
Though most operations of a partnership are controlled by the partnership agreement, there are two major laws, also known as statutes, that play a role: the Uniform Partnership Act (UPA) and the Revised Uniform Partnership Act (RUPA). Every state except for Louisiana has adopted either the RUPA (37 states) or the UPA (the remaining 13 states). These laws dictate how the partnership will operate in the absence of a partnership agreement or a partnership agreement that does not address some key critical issues. Under both the UPA and the RUPA, a partner has the legal right to withdraw from a partnership at any time given that they provide proper notice.
However, the RUPA and the UPA have different rules about what happens to the business itself when a partner withdraws. Under the UPA, withdrawal of a partner from a partnership causes an automatic dissolution of the partnership. According to the RUPA, a partner can withdraw from a partnership without automatically causing the partnership to dissolve. In most cases, when the RUPA is controlling, the partnership may buy out the interest of a partner who leaves without breaking up the partnership itself.
The partners should look to their own state law to figure out which law applies to their business.
Once the partner's withdrawal has been approved by a vote of the partners and the withdrawal process outlined in either the partnership agreement or the relevant state law has been followed, the final step is cashing out the partner's interest in the partnership and transferring their share of the partnership's assets. The partnership agreement, or a buy-sell agreement, controls what the withdrawing partner is entitled to once they leave. An audit of the partnership's debts and assets may be necessary to come up with an accurate number of what the partner's payout should be. Once the partner receives their payout, they often are required to sign a release indicating that they have received the partnership assets that have been transferred to them.
For a partnership that is going out of business, the partners should be sure to formally dissolve their partnership to be sure that their liability for partnership debts ends and that the partners are no longer bound to each other in future business deals without their prior knowledge, agreement, or consent.
After the partners take the crucial first step of voting to dissolve the partnership and recording their decision in writing, there are several steps they should take to tie up loose ends.
What if the partners don't agree to dissolve? If the partners don't vote unanimously to dissolve, and the partnership agreement or state law will not allow the business to close without a unanimous decision, the partnership may have the option to buy out the partner(s) who would like to leave the business. Instead of dissolving the partnership, the remaining partners can keep the enterprise going. If the partners are unable to agree on a buy-out price, they can take the step of hiring a third-party neutral mediator to resolve the conflict. As a last resort, partners can head to court to have a judge resolve the dispute with a court-ordered dissolution.
It is crucial that the partners first discuss the responsibilities they each have regarding the debts, losses, and any futural financial or legal liabilities of the partnership. Without taking care of this issue, the partners put themselves at risk of future liability down the line, even after the dissolution of the partnership. For example, if Partner A pays off one-third of the partnership's debts but Partners B and C do not pay off the remaining two-thirds of the debt owed or file for bankruptcy, creditors can still come after Partner A for the remainder of the partnership's debts.
It is in the partners' best interest to record in writing how they agree to handle any present or future liabilities. Without having a concrete written agreement that describes which partners will be responsible for which part of the debts owed by the partnership, the other partners are still liable for a non-paying partner's debt and can be sued in court for the full amount. These understandings, and other important details regarding the dissolution of the partnership, can be memorialized in a Partnership Dissolution Agreement.
If any assets remain in the partnership they should be distributed to the partners as described in their partnership agreement. Common arrangements include dividing the assets equally among the partners or dividing them according to the same ratio the partners invested in the partnership when they first began, known as their capital investment. When an asset cannot be easily split, such as real estate, the value of the property can be offset with other assets, or the property can be sold and the parties can split the proceeds made from the sale. Without a partnership agreement, state law typically dictates that the partnership must first pay partners according to their share of the initial investment in the business and then distribute any remaining assets equally.
Though not always necessary, depending on the state, it is generally a good idea to file using the state's dissolution of partnership form which can usually be found on the state's secretary of state or corporations division website. This filing serves as additional proof that the partnership has been fully terminated. Typically, filing a partnership dissolution form with the state is not legally required unless paperwork was filed with the state when the partnership was originally formed. For example, in California, a partnership needs to file a certificate of dissolution form only if it filed a statement of authority with the secretary of state when the partners initially formed the partnership. That said, filing a dissolution form makes it crystal clear that the parties are no longer in the partnership and should not be held liable for any future debts.
Within a reasonable time of making the final decision to dissolve the partnership, the partners should notify outside parties who have a stake in the business, such as employees, customers, and creditors. The partners should be sure to alert their vendors and suppliers, reviewing existing contracts and addressing any outstanding obligations, such as payments owed or work in progress. As a shortcut, many people choose to publish a notice in the local newspaper that the partnership is no longer in business. This is a quick way to put all creditors on notice that the partnership, as well as its partners, can no longer incur debts in the name of the business. This is especially important, as mentioned above, because any partner can bind the partnership to a deal or obligation without letting the other partners know for as long as the partnership is still in operation. If creditors do not have proper notice, the partnership could continue to incur debts that the partners may, unbeknownst to them, be responsible for paying later on down the line.
Relatedly, if the partnership has any business licenses or permits, those should be canceled with the applicable licensing divisions. The partners should check for any out-of-state business registrations and notify the appropriate state agencies to take care of wrapping up the business.
About the Author: Malissa Durham is a Legal Templates Programmer and Attorney at Wonder.Legal and is based in the U.S.A.