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Principles Of Business Law - CHAPTER V























































Sec. 33. Nature of. Dissolution of a partnership is effected
when the partnership relation is destroyed by any partner's ceasing
to be a member of the firm. Under the Uniform Partnership Act,
dissolution may occur without violation of the partnership agree-
ment: (a) by the termination of the stipulated term or particular
undertaking specified in the agreement; (b) by the express will of
any partner when no definite term or particular undertaking is
specified; (c) by the express will of all the partners who have not
assigned their interest or suffered them to be charged for their sep-
arate debts either before or after the termination of any specified
term or particular undertaking; or (d) by the expulsion, in good
faith, of any partner from the business, in accordance with such a
power conferred by the partnership agreement.

Sec, 34. Dissolution by act of partner when for definite term.
A partnership agreement, originally created to continue for a def-
inite term, in which no provision is made for dissolution prior to
the expiration of the period, may be dissolved by the acts of one of
the partners "in contravention of the partners' agreement/' By
reason of the partnership agreement there exists between the part-
ners a principal and agency relationship. As in the law of agency,
each partner has the power to revoke such relationship but in so
doing is made liable for damages. A partnership is not indissolv-
able. Because of the peculiar personal relationship necessary in
the formation and carrying out of a partnership agreement, a court
of equity will not grant specific performance for the continuance of
a partnership, even though the agreement provides that such part-
nership shall continue for a long period of time. As a consequence
of such breach the withdrawing partner becomes liable for the dam-
ages sustained by the other parties.

Sec. 35. By operation of law. If, during the period of the
partnership, events occur which make it impossible or illegal for the
partnership to continue, it will be dissolved. Such events or con-
ditions are : death or bankruptcy of one of the partners, or a change
in the law which makes the continuance of the business illegal.

A partnership is a personal relation existing by reason of con-
tract. Therefore, when one of the partners dies, the partnership is
dissolved. The former partners cannot^ bind the estate^ofjhe de-
ceased partner l5y"lTTlgW"~75o^


intended by the_decedent that the partnership b^continued. Al-
TlKough partnership Agreements occasionally provide for the contin-
ued existence of the partnership after the death of the partner, the
agreement does not bind the legal representatives of the deceased
partner to continue the firm in existence. Since a deceased partner
cannot continue as a partner or compel his heirs or legal represent-
ative to become a partner, he occasionally provides that his inter-
est in the firm may be retained by the survivors for a limited pe-
riod. If the -period is not too long three to five years the courts
usually enforce it. The balance of his estate is not thereby made
liable for any future debts or losses, but his estate is delayed in ob-
taining a final accounting from the surviving members of the part-
nership and may share in the profits for the period involved.

If, during the period of a partnership, a law is passed which
makes continuance of the business illegal, the partnership will be
dissolved. Also a partnership composed of residents of different
countries could not legally continue, upon the declaration of war
between such countries, because such parties would be enemies.

The bankruptcy of a partner will dissolve the partnership, be-
cause the control of his property passes to his assignee or trustee,
for the benefit of the creditors, in somewhat the same way that the
control of the property passes to the legal representatives upon the
death of a partner. The mere insolvency of a partner will not be
sufficient to justify a dissolution, unless there has been an assign-
ment of his assets. Neither will a dissolution take place if a part-
ner is involuntarily placed in bankruptcy by one of his copartners.
The bankruptcy of the firm itself is a cause for dissolution, as is also
a valid assignment of all the firm assets for the benefit of creditors.

Sec. 36. Dissolution by court decree. Where a partnership,
by its agreement, is to be continued for a term of years, circum-
stances may arise which might make the continued existence of the
firm impossible and unprofitable. Therefore, upon the application
of one of the partners to a court of equity, the partnership may
be dissolved. The following are the circumstances and situations
which will give a partner a right to go into a court of equity for
dissolution :

Where a partner becomes totally incapacitated to conduct busi-
ness and to perform the duties required under the contract for part-
nership, the court of equity will, upon application by any of the
partners, declare a dissolution. Insanity of one of the partners
does not necessarily dissolve the partnership. If, however, a part-
ner is declared insane by a judicial process, the partnership is dis-

Where a parCTier is guilty of gross misconduct and neglect or
breach of duty to such an extent that it is impossible to carry out
the purposes of the partnership agreement, a dissolution will be de-
creed at the request of the remaining partners. The court will not
interfere and grant a decree of dissolution for mere discourtesy,
temporary inconvenience, differences of opinion, or errors in judg-
ment. 1 The misconduct must be of such gross nature that the con-
tinued operation of the business would be unprofitable. Where a
partner willfully and persistently commits a breach of the partner-
ship agreement, misappropriates funds, or commits fraudulent acts,
the partnership will be dissolved. A partnership which was en-
tered into by reason of fraud may be dissolved on the application
of an innocent party. But, if the defrauded partner continues in
the partnership with the knowledge of the fraud, no decree of dis-
solution will be granted.

Effect of Dissolution Between the Partners

Sec. 37. Where dissolution is caused by acts other than death
or bankruptcy. Upon dissolution, a partnership is not terminated,
but continues in existence for the purpose of winding up the part-
nership affairs. Dissolution terminates all the authority of any
partner to act for the partnership, except in-so-far as it may be nec-
essary to create liability to complete unfinished transactions, or to
liquidate the assets of the firm in an orderly manner.

In the event of dissolution, title to partnership property remains
in the surviving partners for purposes of liquidation. Should
death of one of the partners occur, both real and personal property
is, through the survivors, made available to creditors. If all of the
realty is not required to satisfy firm obligations, the disposition to
be made of the remaining real estate depends on whether the firm
operates under the common law or the Uniform Act, Under the
Act, all realty is treated as though it were personal property, 2 the
surviving partners finally accounting, usually in cash, to the per-
sonal representative of the deceased partner for the latter's share
in the proceeds of liquidation. In those states which have not
adopted the Uniform Act, the surviving partners are authorized to
sell only that portion of the realty which is needed for the payment
of debts. The unsold portion, to the extent of the deceased part-
ner's interest therein, passes directly to the latter's heirs and is sub-
ject to widow's dower and the ordinary incidents of real property
which passes by descent.

Sec. 38. Dissolution caused by death or bankruptcy. Under
the Act, if the dissolution is caused by the act, death, or bankruptcy
of one of the partners, each partner will be liable, just as if no dis-
solution had taken place, upon any contracts entered into after the
dissolution, unless the acting partner had knowledge or notice of
the dissolution. In those states where the Uniform Partnership
Act has not been adopted, and the partnership is dissolved by death
or bankruptcy, each person, including the partners, must take no-
tice of such death or bankruptcy whether or not they have actual
knowledge of the fact. Therefore, if A, a partner in the firm of A,
B, and C, enters into a contract after the death or bankruptcy of
(7, he must assume the entire liability of the contract, although he
or the other partner is ignorant of the death or bankruptcy of C.
Under the Uniform Partnership Act, however, A may call upon B
and the estate of the deceased partner to assume their proportion-
ate share of the liability and to contribute to any loss which may
be sustained on account of such contract.

Sec. 39. Right of partners after dissolution. Where the dis-
solution is caused by any act other than the breach of the partner-
ship agreement, each partner, as against his copartners or their
assignees, has a right to insist that all the partnership assets be used
first to pay firm debts. After firm obligations are paid, remaining
assets are used to return capital investments, 3 proper adjustments
for profits and losses having been made. All of the surviving part-
ners, except those who have caused a wrongful dissolution of the
firm, have the right to participate in the winding up of the business.
The majority may select the method or procedure to be followed
in the liquidation, but the assets, other than real estate, must be
turned into cash unless all the partners agree to distribution in
kind. Under the Uniform Act, realty is treated the same as any
other asset and should be liquidated. Should the last surviving
partner die prior to the final accounting, it becomes the duty of his
legal representative to complete the liquidation.

Sec. 40. Continuation of the business after dissolution. If a
partnership which is to continue for a fixed period is dissolved by
the wrongful withdrawal of one of its members, the remaining
members may continue as partners if they have settled with the
withdrawing partner for his interest in the partnership. The re-
maining partners, in determining the interest of the withdrawing
partner, have the right to pay him his share in cash, less damages.
In the calculation of his share, the good will of the business is not
taken into consideration. Under the Uniform Partnership Act, if
no accounting is made at the time that the partner withdraws, the
remaining partners may continue the business for the agreed pe-
riod by securing the payment of such withdrawing partner's inter-
est by a bond approved by the court, covering not only the part-
ner's interest at the time of the withdrawal, but also indemnifying
him against any future liabilities of the continuing partnership.

The right of the partners to expel one of their number is deter-
mined entirely by the partnership agreement. Thus, the right to
continue after expulsion, as well as the amount which the expelled
partner is to receive, depends exclusively upon the articles of co-

Effect of Dissolution as to Third Parties

Sec. 41. Liability existing prior to dissolution. Although the
dissolution of a partnership terminates the authority of the part-
ners to create future liability, it does not discharge the existing lia-
bility of any partner. An agreement between the partners them-
selves that one or more of the partners will assume the partnership
liabilities does not bind the firm creditors. However, upon dis-
solution, a partner may be discharged from any existing liability by
an agreement to that effect in which he, the partnership creditors,
and the remaining partners join. Such an agreement must satisfy
all the requirements for a novation. If, upon dissolution of a part-
nership, an incoming partner or the remaining partners promise to
assume the liabilities of the dissolved partnership, such liabilities
will be discharged as to the withdrawing partner if any creditor of
the partnership, knowing of the agreement, changes or alters the
character of the liability or the time of its payment by agreement
with the new firm.

The individual estate of a deceased partner is liable to third par-
ties for all debts created while he was a partner, subject, however,
to the payment of his separate debts.

Sec. 42. Notice to the creditors of the firm. Transactions en-
tered into with former creditors of the firm who have not received
actual knowledge of the dissolution continue to bind any partner
who has withdrawn. Notice of the dissolution is not necessary at
common law, where the dissolution has been caused by the opera-
tion of the law. If the dissolution has been caused by agreement
or an act of the parties, notice which carries knowledge to all per-
sons who are creditors to the firm is required, as in the revocation
of agency. 4 Therefore, a retiring partner, who fails to give notice
of dissolution to those who have extended credit to the old firm,
assuming that knowledge of the dissolution has not been acquired

4 Joseph, Gaboury & Co. v. Southwark Foundry & Machine Co., 1891, 99 Ala. 47;
p. 682.


in some other manner, will be liable on contracts of the new firm.
Under the Uniform Partnership Act notice of dissolution is re-
quired even though the dissolution is caused by operation of law,
except where a partner becomes bankrupt. In the latter case no-
tice is not required.

Sec. 43. Notice to the public generally. Where the dissolu-
tion is caused by an act of the parties, the partners will continue to
be liable to all persons who formerly dealt with the firm, but not
on credit, and to all other persons who extend credit on the faith
of the old firm, unless notice of such dissolution is given to the pub-
lic at large. This does not mean that notice of the dissolution must
be brought to the attention of all third parties. Notice by publi-
cation in a newspaper in the community where the business has
been transacted or notice of the dissolution by a properly addressed
envelope placed in the mailbox is sufficient.

The duty td impart notice is broadened by the Uniform Act to
include those situations where dissolution results from operation of
law. Thus, in states operating under these laws, it becomes the
duty of the estate of a deceased partner to see that notice is given.
Should the continuation of the business become illegal, however,
notice is not required, since all are presumed to be aware of the il-
legal nature of the enterprise.

Where a partner has not actively engaged in the conduct of the
partnership business and credit has not been extended to the firm
on the faith of such partner, he is under no duty to give notice to
either of the groups mentioned above.

Sec. 44. The liability of an incoming partner. Under the
common law an incoming partner causes a change in the person-
nel of the partnership to the extent that a new firm is formed, and
he is, therefore, not liable as a member of the new firm to creditors
of the old firm. He may make himself liable, however, to old firm
creditors by assuming the liability. This agreement may take the
form of a novation, a contract of suretyship, or a mere contract for
the benefit of third parties. Under the Uniform Partnership Act,
however, a person admitted as a partner into an existing partner-
ship is, as a member of the firm, liable to the extent of his invest-
ment for all obligations created before his admission, as though
previously he had been a partner. His separate estate is not liable
for such obligations, and the creditors of the old firm can look only
to the firm assets and to the members of the old firm. 5

Sec. 45. Creditors of the old firm and the new firm. Under
the Uniform Partnership Act, if the business is continued without
liquidation of the partnership affairs, creditors of the first, or dis-

6 Freeman v. Huttig Sash & Door Co., 1913, 105 Tex. 560, 153 S.W. 122; p. 684.


solved, partnership are also creditors of the partnership continuing
the business. Likewise, if the partners assign all their interest to
a single partner, who continues the business without liquidation
of the partnership affairs, creditors of the dissolved partnership
are also creditors of the single person so continuing the business.
Likewise, when all the partners or their representatives assign their
rights in the partnership property to one or more third persons who
promise to pay the debts and to continue the business, the creditors
of the dissolved partnership are also creditors of the person or per-
sons continuing the business.

Distribution of Firm Assets and Liabilities of Partners on


Sec. 46. Distribution of firm assets where firm is solvent.

Upon the dissolution of a partnership and a winding up of its busi-
ness, an accounting is had to determine its assets and liabilities.
Before the partners are entitled to participate in any of the assets,
whether firm creditors or not, all firm creditors other than partners
are entitled to be paid. After firm creditors are paid, the assets of
the partnership are distributed among the partners, as follows:

1. Each partner who has made advances to the firm, or has in-
curred liability for or on behalf of the firm, is entitled to be reim-

2. Each partner is then entitled to the return of the capital which
he has contributed to the firm. 6

3. Any balance is distributed as profits, in accordance with the
partnership agreement.

Sec. 47. Firm creditors against firm assets. When the firm is
insolvent and a court of equity has acquired jurisdiction of the as-
sets of the partnership, together with the assets of the individual
partners, the assets are distributed in accordance with certain well-
defined rules.

Persons entering into a partnership agreement, by virtue of the
contract itself, impliedly agree that the partnership assets shall be
used in the payment of the firm debts before the payment of any
debts due to the partners themselves. Consequently, a court of
equity, in distributing firm assets, will give priority to firm credi-
tors in firm assets as against the separate creditors of the individual
partners. This rule does not apply, however, if a partner conceals
his existence and permits another member of the firm to deal with
the public as an individual proprietor. Under these circumstances
the dormant partner by his conduct has led the creditors of the ac-
tive partner to rely upon firm assets as separate property, and by

6 Livingston v. Blanchard, 1881, 130 Mass. 341; r>. 6S/L


reason of his conduct he is estopped from demanding an applica-
tion of the equity rule that firm assets shall be used to pay firm
creditors in priority, and individual assets to pay individual credi-
tors. Since the firm creditors' right to firm property rests upon the
partners' right that firm assets be used to pay firm debts, the con-
duct that estops a partner also denies the creditors such a prefer-
ence. Furthermore, the creditors who relied upon the assets in the
hands of the sole active partner cannot claim a preference when
later they learn such assets were partnership assets.

Sec. 48. Firm creditors against individual assets. Just as the
individual creditors are limited to individual assets, firm creditors
are limited to firm assets. Therefore, firm creditors are not en-
titled to payment out of the individual assets of the partners until
the individual creditors have been paid. This rule applies, even
though the firm creditors may, at the same time, be individual cred-
itors of a member of the firm. There are two main exceptions to
this general rule. (1) Where there are no firm assets and no liv-
ing solvent partners. The rule for the limit of firm creditors to
firm assets applies only where there are firm assets. If no firm as-
sets or no living solvent partner exists, the firm creditors may share
equally with the individual creditors in the distribution of the in-
dividual estates of the partners. 7 (2) If a partner has fraudulently
converted the firm assets to his own use, it follows that the firm
creditors will be entitled to share equally with individual creditors
in such partner's individual assets.

Review Questions and Problems

1. A, B, and C are partners, and by the terms of the agreement the
partnership is to continue for a period of five years. At the end of the
third year conditions have arisen, which indicate that the firm cannot
continue except at a loss. B and C refuse to quit and A files a bill to
obtain an order for dissolution. Should he succeed?

2. Name three events which automatically cause a dissolution. Name
three situations in which a court will decree a dissolution.

3. What contracts does a partner have a right to make after dissolu-
tion? What change did the Uniform Partnership Act make in the lia-
bility of partners for contracts made on behalf of the firm, following
bankruptcy and death?

4. A, B, and C are partners under an agreement whereby the firm is
to continue in business for ten years. A causes a wrongful dissolution of
the partnership and demands his interest therein. May he demand that
firm assets be liquidated? Is there any asset in which he is not entitled
to share?

7 Emanuel v. Bird, 1851, 19 Ala. 596, 54 Am. Dec. 200; p. 685.


5. A withdraws from a firm under an agreement with the surviving
partners that they shall assume and pay all outstanding liabilities. A
notified all creditors of his withdrawal from the firm. The surviving
partners failed to pay the debts. Has A avoided liability therefor?

6. A, Bj and C take a new partner, D, into their business. He invests
$3,000. What is the extent of his liability, if any, to creditors of the old
firm? What are the rights of creditors of the old firm, in comparison
with creditors of the new firm, in the firm assets?

7. To what parties does a withdrawing partner owe a duty to give
notice of his withdrawal? How should this notice be given?

8. Name the order of payment of firm assets in the case of a solvent

9. In the event of the insolvency of a firm at dissolution, have in-
dividual creditors of an insolvent partner any right to share in firm

10. Do the creditors of an insolvent firm ever share in the insolvent
individual estate of a partner?

11. A y By and C are partners. The firm is insolvent and is being wound
up in a bankruptcy court. The firm assets amount to $40,000, its liabil-
ities to $80,000. A has personal property worth $12,000; his personal
liabilities are $6,000. B has personal property worth $20,000; he owes
personal creditors $15,000. C has no personal property and owes per-
sonal creditors $5,000. Marshal the assets of the firm and make the
proper distribution between firm and individual creditors.

12. A, B, and C are partners. A contributed $10,000, B contributed
$4,000, and C contributed his services. Upon dissolution it was found
that the firm had assets of $50,000 and liabilities to outside creditors of
$20,000. C had loaned the firm $1,000 and had paid $300 in taxes and
$450 insurance. Make the proper distribution of the firm assets.

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