It is preferable that the possibility of a partnership dissolving is dealt with in the original partnership agreement. If not, the law provides a variety of circumstances which will lead to it. If the business is disposed of after a partnership dissolution, there is a set procedure as to what will happen to the proceeds.
Dissolution of a partnership occurs when the contractual relationship joining all of the current partners together comes to an end. In cases where one member withdraws from a partnership, the remaining partners may carry on running the business as before, but technically a new partnership is formed.
The circumstances for and the consequences of dissolution can be specified in a partnership agreement. However, if they are not so specified, the general provisions of the Partnership Act 1890 (the 'PA') can be applied. Under the PA, a partnership is dissolved should any of the following events occur:
Normally the question of duration and dissolution of the partnership will be dealt with in the partnership agreement as opposed to being governed by the PA. The partners will not want the death or bankruptcy of one partner to cause dissolution of the partnership between the survivors.
The agreement will also contain provisions allowing for the remaining partners to purchase the share of the former partner and fixing the terms of the purchase.
If the partners cannot agree that some of them will continue the partnership business and purchase the outgoing partner's share, it will be necessary for there to be a disposal of the business and for the proceeds of sale to be used to pay off creditors, and then to pay to the partners the amount to which they are entitled.
The disposal of a business may be by sale as a going concern (i.e. selling the business) or, if a buyer cannot be found, by breaking up the business and selling its assets separately. There is a serious financial disadvantage to the partners if the business is not purchased as a going concern. This is because the goodwill of the business is ignored if the assets are being sold separately. Goodwill is the benefit of the business's reputation and connections and the benefit of having its own momentum, so that profits will continue to be earned because the business is established.
Unless there is an agreement to the contrary, the proceeds of sale of the business or its assets will be used in the following sequence:
First, creditors of the firm must be paid in full. If there is a shortfall so that the firm is insolvent, the partners must pay the balance from their private assets. Secondly, partners who have lent money to the firm must be repaid, together with any interest to which they are entitled. Thirdly, partners must be paid their capital entitlement. Finally, if there is a surplus, this will be shared between the partners in accordance with their partnership agreement.