Associations Class Notes
More on the dissolution of partnerships
Accounting is crucial.† In Cauble, if the original agreement had provided that the payout to the widow of the deceased partner would have been in three or four equal annual installments that it also would have held up.† Sometimes the capital accounts are huge and there is no way the remaining partners can have a check written quickly for the capital account.† In Cauble, because of the way ß 38 of the Uniform Partnership Act of 1914 reads, if the parties had agreed up-front that the widowís profit interest would have terminated at her husbandís death and that there would have been no interest (or interest at a non-usurious rate) that also would have held up.
Some finance overview
In the mid-1950ís, there were seven or eight dominant Wall Street securities firms.† At that time, they were all partnerships.† Their capitalization (by todayís standards) was amazingly small: only $25-30 million.† Itís still small even when you adjust for inflation.† The big firms now have billions in capital.† But there were problems: they soon realized that now and again even the best run brokerage goes broke.† Also, among your partners, you will have some with very large capital accounts, to the tune of several million.† How do you deal with the widows of the partners as they die?† If you did nothing and went with the UPA, the widow will get her money in a few months, just as it says in Cauble.† First, they switched to limited partnerships and tried to talk the widows into transferring their capital accounts to limited partnership status at a good fixed rate (like 9%).† Then they discovered that they had to make the same deal with retired partners.† These problems also crop up in close corporations.† People fail to consider the possibility that someone will die or retire.
Within limits, you can specific when, how, and how much the payout will be upon dissolution.† But if the sections say that something is a dissolution, you canít specific that thing as a non-dissolving event.† For example, you canít agree that death constitutes dissolution.† Itís only half true that you can contract to determine what dissolution is.† You can specify that there will be events of dissolution in addition to what the statute deals with.
fiduciary duty override will sometimes conflict with literal contract or statutory
provisions and working out the conflict is not
mechanical.† The RUPA deletes the
provision that there is a fiduciary duty in formation.† They still leave the fiduciary duty in
GAAP accounting is accrual accounting.† If you sell something on credit, you take in the income and you increase the capital account immediately.† In other words, you accrue immediately.† For tax purposes, any business using an inventory must use the accrual method.† What does the Internal Revenue Code provide as to professionals?† For service professions, regardless of income, you can use the cash method, that is, accounts receivable are neither an asset nor income until they are collected.† The capital account will not reflect unrealized receivables.† If you are on the accrual method, the capital account will reflect such receivables.† Independent CPAs will certify statements on the cash method, but they will put legends on the statements saying that a non-GAAP method is being used.† The pure cash method is not a traditional GAAP method.
lawyers and doctors use the cash method because, from a business standpoint, their
cash flow runs far behind the provision of services.† This may not always have been true,
especially with doctors.† They may have
taken cash at the time of service.† For
other businesses, once you reach a certain size, you must use accrual
accounting.† This is mainly a matter of
the political power of lawyers and doctors.†
this case, we have a medical partnership on the cash method.† The partnership agreement provided for what a
rightful or wrongful withdrawing partner would get: if the partner pulls out
five months into the year and has a one-fourth profit interest, then he will
get his pro-rata income for the year: 5/12 times ľ.† He will also get what is in his capital
account at book value.† Thus, the Cauble result of fair market
value (and possibly some goodwill) is precluded.† The problem is that theyíre using the cash
method, and as of May 31st, there may be up to $500,000 coming in as
accounts receivable.† The departing
partner could be forfeiting $125,000 by leaving early!† On a very literal reading, this squares with the
first sentence of ß 38.† But weíre
nervous because all the parties are fiduciaries with each other, and the law
generally abhors forfeitures.† All
dissolution and accounting proceedings are equity proceedings!† The court says something that Shipman claims
is only half true: the partners defined this as a non-dissolution
and thatís okay because ß 38 allows you to do that.† But the court is overreaching, according to
Shipman.† If you read between the lines,
this case says that this penalty is good policy because it tends to make people
live up to their contracts.† In a later
Very commonly, whenever a law partner rightfully withdraws, retires or dies, he will get a pro-rata share of that yearís income, the amount in his capital account computed by book value, but no goodwill.† The capital account payoff is often over the course of several years.† Why is it done this way?† Under Internal Revenue Code, if the agreement provides that no part of the continued profit participation is for goodwill, then the recipient includes that payment in income.† But the good news is that the other partners get to deduct or exclude that payment.† Subchapter K is the only part of the Internal Revenue Code where you can buy out a business with after-tax income.† You canít do it any other way.† As to the return of the capital account, if, for example, it goes to a widow, the payment will be tax-free because taxes have already been paid.
is an old Court of Appeals of
Meehan v. Shaughnessy
This is an unusual partnership agreement in that it lumps rightful and wrongful dissolution together and provides what is going to happen.† The court looks at the agreement and basically ratifies the agreement.† It sees no conflict between the agreement and the UPA.† In this case, some of the partners went to young associates and solicited business for their new firm.† They held that the old per se rule of setting up shop while being employed didnít apply to a law firm because at a law firm the main parties to be protected are the clients, and the clients canít get good service unless there is work up front.† The court found a violation, holding that the old partners had a right to have their solicitation sent to the clients at the same time that the departing partners sent theirs.† Note that you canít forcibly take clients with you.
8182 Maryland Associates, Limited Partnership v. Sheehan
What happens when there is a joint judgment against all those partners plus the partnership?† In the case of Wayne Smith from the Ohio Supreme Court, it is held that where there is joint liability in contract, you must first try to get satisfaction at the partnership level, meaning that your suit is both against the partnership and all partners, because if you omit one partner you canít go back later and get Ďem.† In tort, you can move ďsequentiallyĒ.† Later, it was held that when you go to the two 50% partners, the creditor should try to get 50% from each, but if one is a turnip, then after trying to divide it 50-50, you can get 100% from the other.† Weíre into guaranty and surety again.† If you are a creditor of a partnership and you let one partner off, some cases will hold that you have released everyone.† Furthermore, if the partnership has to pay something by June 1st and you get that date pass without suing them, then in many states the partner who has ditched is released under surety and guaranty law.† If there are former partners you want to reach, then before you extend the due date of the partnership, get all twelve partners to consent.† Otherwise, if you extend as to the four that you will try to reach on surety grounds then you will screw up.
Along the same lines, there was a big case from the 1960ís from the California Court of Appeals dealing with tort liability.† There was a general partnership for the practice of law.† Smith was a general partner.† While he was a partner, Jones, another partner, brought a personal injury client in.† Smith did not know about it.† After he left, Jones mishandled the case and let the statute of limitations run.† The client sues the partnership, current partners, and Smith, the retired partner.† Smith says he wants out!† He argues that the old firm was dissolved and the negligence occurred after he left.† The UPA tells us that the old firm continues until winding up, and for a tort client, thatís not until youíve completely finished a case, which may be 10-12 years later!
do you protect yourself on torts if youíre a retiring partner?† The firm today is usually an LLP.† If you didnít bring the client in and you
didnít supervise or screw up, youíll have a defense under the LLP statutes.† The other thing that you do is in the
retirement agreement with the firm you get the firm to agree to have the
malpractice policy cover not only current partners and employees but former partners
and employees too.† If the firm wonít do
it and itís not an LLP, go buy yourself tail coverage.† In