DISSOLUTION AND WINDING UP

DEFINE DISSOLUTION.

Dissolution is the change in the relation of the partners caused by any partner ceasing to be associated in
the carrying on the business (Art. 1828). It is the point in time when the partners cease to carryon the
business together.

IS THE PARTNERSHIP TERMINATED ON DISSOLUTION?

No, it continues until the winding up of partnership affairs is completed. (Art. 1829) The principal
significance of dissolution is that thereafter no new partnership business should be undertaken, but
affairs should be liquidated and distribution made to those entitled to the partner’s interest.

DIFFERENTIATE WINDING UP AND TERMINATION.

WINDING UP is the process of settling the business or affairs of the partnership after dissolution after
which the existence of the partnership is terminated.

TERMINATION is the point in time when all the partnership affairs are wound up or completed, and
the partnership ceases to exist for all purposes.

WHAT ARE THE CAUSES FOR THE DISSOLUTION OF A PARTNERSHIP?

They are:

1. Without Violation of Partnership Agreement:

(a) Termination of the agreed term or of the particular undertaking;
(b) By the express will of any partner who must act ii faith (otherwise, the partner will be liable for
damages), when no definite term or particular undertaking is specified;
(c) By the express will of all the partners except those:
1) who have assigned their interest; or
2) suffered them to be charged for their separate debts; and
(d) By expulsion of any partner. Reason: It has the effect of decreasing the number of partners. The
partner expelled in bad faith can claim damages;

(2) In violation of partnership agreement:

(a) By the express will of any partner at any time (with or without justifiable cause). Reason: A partner
cannot be compelled to remain in the firm against his will;
(b) By any event making it unlawful for the partnership or members thereof to continue the business;

(3) By any event making it unlawful for the partnership or members thereof to continue the business;

(4) By loss of specific thing which a partner had promised to contribute before delivery. Reason: There is
no contribution. If only the use or enjoyment of the thing is contributed, the partner having reserved the
ownership thereof, the loss of the same before or after delivery dissolves the partnership. Reason: The
partner bears the loss and, therefore, he is considered in default with respect to his contribution;

(5) By the death of any partner. Reason: It causes a decrease in the number of partners;
(6) By the insolvency of any partner or the partnership. Reason: The business of a partnership requires
ability to meet obligations to creditors;

(7) By the civil interdiction of any Partner. Reason: It results in his incapacity to enter into dispositions of
property inter vivos (i.e. during his lifetime); and

(8) By judicial decree in cases provided by law (Art. 1830)

Note: Civil interdiction deprives the offender during the time of his sentence or imprisonment of the right
to manage his property to dispose of the same by any act to take effect during his lifetime. (Art. 34,
Revised Penal Code)

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GIVE THE CASES WHEN THE COURT MAY DECREE A DISSOLUTION OF THE PARTNERSHIP.

In the following instances:

(1) On the application by or for a partnership:

(a) In case of a partner's insanity;
(b) When a partner becomes incapable of performing his part of the partnership contract;
(c) When a partner is guilty of conduct tending to affect prejudicially the business;
(d) In case a partner willfully or persistently commit a breach of the partnership agreement or such
misconduct which makes it no longer practicable to carry on the business with him;
(e) When the business can only be carried on at a loss; and
(f) Other circumstances making dissolution equitable (like fraud in the management of the business,
undue refusal to render accounting or to allow inspection of partnership books, etc.)

(2) On the application by a purchaser of a partner’s interest (under Arts. 1813, 1814):
(a) After the termination of the specified term or particular undertaking; or
(b) at any time if the firm was a partnership at will when the interest was assigned or the charging order
was issued. (Art. 1831).

WHAT IS THE EFFECT OF DISSOLUTION ON THE AUTHORITY OF THE PARTNERS TO ACT FOR
THE PARTNERSHIP?

(1) General Rule – Dissolution terminates all authority of any partner to act for the partnership.

(2) Exceptions:
(a) When necessary to wind up partnership affairs; and
(b) When necessary to complete transactions begun but not then finished. (Art. 1832.)

GIVE THE EFFECTS IN CASE NEW CONTRACTS ARE BY A PARTNER WITH THIRD PERSONS
AFTER DISSOLUTION.

(1) As among the partners themselves. — The other partners are not bound (although they may be liable
to third persons) –
(a) when the dissolution is not by the act, insolvency, or death of a partner (e.g., expiration of the term);
or
(b) when the dissolution is by the act of any partner (e.g. resignation) and the partner acting for for the
partnership had knowledge of the dissolution; and
(c) when the dissolution is by the death or insolvency of a partner and the partner acting for the
partnership had knowledge or notice of the death or dissolution, (Art. 1833)

EXAMPLES:

(1) A, B, and C were partners. A informed B that the former was resigning from the partnership.
The partnership was thus dissolved by the act of A. C had no knowledge of the dissolution. If
partnership liability is incurred by a contract entered into A and B are bound to contribute their
share of the liability as if the partnership had not been dissolved.

(2) If the contract was entered into by B despite his knowledge of the dissolution, A and C can
recover from B. In the end, only B will assume the entire liability.

Suppose B learned of the resignation of A only through a letter from C. In this case, B had merely
notice (as distinguished from knowledge) of the dissolution. Hence, A and C can be called upon
to contribute their share in the liability.

(3) If A had died or had become insolvent, knowledge or notice on the part of B will justify non-
liability on the part of the other partners.

(2) With respect to third persons. — The partnership is generally bound by the new contract. (Art. 1834).
In such case, the innocent partners can recover from the acting partner.

EXAMPLE:

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 A, B, and C were partners in X & Co. The term of existence of the partnership as fixed in the articles of
partnership expired yesterday. Therefore, it was dissolved. Here the dissolution was caused not by the
act, insolvency, or death of a partner.

If today A enters into a new transaction with D, A alone assumes whatever liability may arise under the
contract because his authority to act for the partnership X & Co. as to bind B and C terminated as of
yesterday when the partnership was dissolved. If the partnership is liable to D (a third person) under Art.
1834, B and C are entitled to indemnity (reimbursement) from A.

WHAT ACTS OR TRANSACTIONS WILL BIND A PARTNERSHIP EVEN AFTER DISSOLUTION?

They are:
(1) Acts appropriate for winding up;
(2) Acts appropriate for completing transactions unfinished at dissolution; and
(3) Transactions which would bind the partnership if dissolution had not taken place provided the third
person — (a) Had extended credit to the partnership prior to dissolution; or
(b) Had not so extended credit but had known of the partnership prior to dissolution and having no
knowledge or notice of dissolution, the fact of dissolution had not been advertised in the newspaper of
general circulation in the place at which the partnership was regularly carried on. (Art. 1834.)

IN WHAT CASES IS A PARTNERSHIP NOT BOUND BY ANY ACT OF A PARTNER AFTER

DISSOLUTION?

In the following cases:

(1) When the partnership is dissolved because it is unlawful to carry on the business unless the act is
appropriate for winding up partnership affairs;
(2) Where the partner has become insolvent; or
(3) Where the partner has no authority to wind up partnership affairs excepts a otherwise provided by
law (Art. 1834).

WHAT ARE THE TWO (2) WAYS OF WINDING UP A DISSOLVE PARTNERSHIP?

They are:
(1) Judicially. — under the control and direction of the proper court upon cause shown by any partner,
his legal representative or his assignee; or
(2) Extra-judicially —by the partners themselves without intervention of the court. (Art. 1836.)

WHAT ARE THE RIGHTS OF EACH PARTNER IN CASE OF DISSOLUTION WITHOUT VIOLATION
OF PARTNERSHIP AGREEMENT?

Unless otherwise agreed —

(1) To have the partnership properties applied to discharge the liabilities of the partnership; and
(2) To have the surplus, if any, applied, to pay in cash the net amount owing to the respective partners.
(Art. 1837.)

WHAT ARE THE RIGHTS OF THE INNOCENT PARTNERS IN CASE OF DISSOLUTION IN

VIOLATION OF PARTNERSHIP AGREEMENT?

They are:

(1) To have partnership property applied for the payment of its liabilities;
(2) To receive in cash their share of the surplus;
(3) To be indemnified for damages caused by the partner guilty of wrongful dissolution;
(4) To continue the business in the same name during the agreed term of the partnership by themselves
or jointly with others; and
(5) To possess partnership property should they decide continue the business. (Art. 1837)

WHAT ARE THE RIGHTS OF THE PARTNER WHO WRONGFULLY CAUSED THE DISSOLUTION?

They are:
(1) If the business is not continued by the other partners –
(a) To have partnership property applied to discharge its liabilities; and
(b) To receive in cash his share of the surplus less damages caused by his wrongful dissolution.

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(2) If the business is continued –
(a) To have the value of his interest in the partnership (but the value of the goodwill of the business is
not considered) at the time of dissolution ascertained and paid in cash or secured by bond approved by
the court; and
(b) To be released from all existing and future liabilities of the partnership.

WHAT ARE THE RIGHTS OF THE INJURED PARTNER WHERE THE PARTNERSHIP CONTRACT
IS RESCINDED ON THE GROUND OF FRAUD OR MISREPRESENTATION?

They are:

(1) Right of a lien or retention of the surplus of partnership property after satisfying partnership liabilities
for any sum of money contributed or paid by him.
(2) Right to subrogation (i.e., right to step into the shoes of another, acquiring all his rights) in place of
partnership creditors after payment of partnership liabilities;
(3) Right of indemnification by the guilty partner against all debts and liabilities of the partnership; and
(4) Such other rights to which he is entitled under the provisions of law. (Art. 1838.)

STATE THE RULES FOR THE DISTRIBUTION OF PARTNERSHIP ASSETS AFTER DISSOLUTION.

Subject to any agreement to the contrary, they are as follows:

(1) Assets of the partnership. – They are:

(a) Partnership property (including goodwill); and
(b) Contributions of the partners necessary for the payment of all liabilities in accordance with Article
1797.

(2) Order of application of the assets- The partnership assets shall be applied to the satisfaction of the
liabilities of the partnership in the following order:
(a) First, those owing to partnership creditors;
(b) Second, those owing to partners other than for capital and profits such as loans given by the partners
or advances for business expenses;
(c) Third, those owing for the return of the capital contributed by the partners; and
(d) Lastly, the share of the profits, if any, due to each partner.

(3) Right of a partner where assets are insufficient. — If the assets enumerated in No. 1 are insufficient,
any partner or his legal representative (to the extent of the amount which he has paid in excess of his
share of the liability), or any assignee for the benefit of creditors or any person appointed by the court,
shall have the right to enforce the contributions of the partners provided in Article 1797.

(4) Liability of deceased partner's individual property. — The individual property of a deceased partner
shall be liable for his share of the contribution necessary to satisfy the liabilities of the partnership
incurred while he was a partner. (Arts. 1816, 1835, par. 3.)

(5) Priority of payment of partnership creditors/partner's creditors. —When partnership property and the
individual properties of the partners are in possession of the court for distribution, partnership creditors
shall first be paid from partnership property and separate creditors from the individual properties of the
partners (see Sec. 51, Act No. 1956, as amended [The Insolvency Law] —XI.)

(6) Distribution of property of insolvent partner. — If a partner is insolvent, his individual property shall
be distributed as follows:
(a) First, to those owing to separate creditors;
(b) Then, to those owing to partnership creditors; and
(c) Lastly, to those owing to partners by way of contribution (Art. 1839).

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EXAMPLES:

(1) A, B and C are partners. A contributed P150,000.00, B - P100;000, and C - P50,000. On dissolution,
the assets of the partnership amounted to P500,000. The partnership owes D the amount of P70,000., E-
P50,000, and A – P20,000.

(2) The accounts of the partnership shall be settled as follows:

(a) D and E, who are partnership creditors, shall be paid first the total sum of P120,000 leaving a
balance of P380,000.00;

(b) Then, A, who is also a creditor, will be paid his credit of P20,000, leaving a balance of
P360,000.00;

(c) Afterwards, the contributions of A, B, and C to the partnership capital shall be returned to
them in the total sum of P300,000, thereby leaving a balance of P60,000;

(d) The balance of P60,000 constitutes the profit which shall be divided among A, B, and C
(unless there is an agreement to the contrary which, however, cannot prejudice the rights of third
persons) in proportion to their capital contributions. Therefore, A is entitled to 3/6 or P30,000, B - 2/6 or
P20,000, and C - 1/6 orP10,000.

(3) Suppose, in the same example, the. liabilities of the partnership amount to P560,000. The partnership
assets, then, shall be exhausted to satisfy these liabilities thereby leaving an unpaid balance of P60,000.
The partners shall then contribute to the loss, in the absence of an agreement to the contrary, in
accordance with their capital contributions. Consequently, A is liable out of his separate property in the
amount of P30,000, B, P20,000, and C, P10,000.

These contributions which are necessary to pay the liabilities of the partnership are considered
partnership assets (1, b) and any assignee for the benefit of creditors and any person appointed by the
court may enforce the contributions.

In case C paid the whole amount of P60,000, then he has a right to recover the amount which he has
paid in excess of his share of the liability from A – P30,000 which he has paid ^excess of his share of the
liability from A - P30,000, and from B - P20,000.

(4) If B is already dead, his estate is still liable for the contributions needed to pay off the partnership
obligations provided they were incurred while he was still a partner

(5) Suppose now that under Nos. 1 and 2 above, C owes F P40,000. Following the rule that the
partnership creditors have preference regarding partnership property, only the share of C in the amount
of P10,000 can be used to pay his debt to F and the unpaid balance of P30,000 must be taken from the
individual property, if any, of C.

(6) Suppose again, that the partnership debts amount to P560,000 as in No. 3. So, C is still liable out of
his separate property to partnership creditors in the amount of P10,000. His separate property amounts
to P45,000. In this case, his assets shall first be applied to pay his debt of P40,000 to F and the balance
of P5,000 to pay part of his debt of P10,000 still owing to partnership creditors in accordance with the
rule that regarding individual properties, individual creditors are preferred.