When a partnership or a corporation winds up its operations, it has to liquidate and distribute its assets to the owners or shareholders. The partnership or corporation must assemble its assets, settle with creditors and debtors, and apportion its remaining assets among the owners or shareholders.

Partnership Dissolution

In a partnership dissolution, each partner is entitled to have partnership property applied to pay partnership debts and to have the surplus, if any, distributed to him according to his interest in the firm. This rule is known as a ''partner's lien.'' The sale of assets and conversion to cash is not mandatory if the assets can be distributed in kind.

If there is no law to the contrary, the partners of either a general or limited partnership, as between themselves, may include in the partnership agreement any terms they wish concerning the sharing of profits and losses, priorities of distribution on winding up of the partnership affairs and other matters.

The partnership agreement controls, if it is complete as between the partners. If the manner of dissolution is not discussed in the partnership agreement, the partners can develop a dissolution agreement for that purpose.

Some states have specific laws that apply to the distribution of assets. In these states, to pay liabilities, partnership property is distributed first, followed by contributions from the partners to the extent necessary. Subject to any agreement to the contrary, partnership liabilities must be paid in the following order:

  1. Those owing to creditors other than partners
  2. Those owing to partners other than for capital and profits
  3. Those owing to partners in respect of capital
  4. Those owing to partners in respect of profits

While the partners may provide by agreement to vary these priorities as among themselves, they cannot change the priorities of the creditors nor modify their personal liability to the firm's creditors.

Limited Partnerships

In many respects the laws governing the dissolution of limited partnerships and the winding up of their affairs are the same as for general partnerships. However, there are some differences, including the limited partner's priority in getting paid.

A limited partner has the rights of a general creditor with respect to claims against the partnership other than for his contributions. Therefore, where a limited partner deals with the partnership, not in his capacity as a limited partner, but in the capacity of a third person, he is treated the same way as any other creditor as to those transactions. For example, a limited partner who loans money to the partnership in his capacity as a third party and not as a member of the partnership will be reimbursed at the same time and at the same percentage as the general creditors of the partnership.

Conversely, any claims by a limited partner in respect of his share of the profits and other compensation resulting from his contribution will be paid after the claims of a general creditor of the partnership.

Some state laws do not give limited partners priority over general partners as to the distribution of assets upon dissolution and winding up of the partnership. However, members may, as between themselves, make any agreement they wish regarding the distribution of assets upon the termination of the partnership.

Corporations

Corporations can also be dissolved and liquidated. A corporation is dissolved when it ceases to exist as a legal entity. A liquidated corporation, on the other hand, is one that has collected its assets, paid its debts, and distributed what remained to its shareholders. The corporation is dissolved, and the corporate assets are liquidated. ''Winding up'' is the process of liquidating.

In a voluntary dissolution, the shareholders usually adopt a plan of dissolution, which sets forth the steps that will be taken toward liquidating the corporation:

  • Collecting the corporate assets
  • Paying or providing for corporate debts, and
  • Indicating how the remaining assets will be distributed to the shareholders

In the liquidation of an insolvent corporation, usually carried out by a trustee in bankruptcy, the corporation's creditors will recover only a fraction of their claims. Laws govern the order in which the corporation's assets will be allocated among its creditors. A creditor's priority depends on the nature of its claim.

In the liquidation of a corporation dissolved as a result of court action, a court-appointed person must work out a liquidation plan under court supervision. If the corporation is insolvent, the claims have to be paid according to established rules of priorities for distributions:

  • First priority goes to the expenses of the liquidation
  • Second priority goes to the debts and obligations of the corporation
  • Last priority goes to the shareholders
  • Questions for Your Attorney

    • In a partnership dissolution, who gets the assets remaining after partnership debts have been paid?
    • Can partners of a liquidating partnership change the priorities of outside creditors in the distribution of partnership assets?
    • Can a limited partner in a liquidating partnership have the same priority as general creditors?

    Tagged as: Business Law, Small Business Law, closing business, assets distribution