As with companies business assets must be used to pay the debts of a partnership. However, unlike most companies, members of partnerships do not benefit from the advantage of limited liability and consequently their personal wealth may be called upon to pay off business debts. Upon dissolution, the value of the partnership property is realised and the proceeds are applied in the following order:
(i) in paying debts to outsiders;
(ii) in paying to the partners any advance made to the firm beyond their capital contribution;
(iii) in paying the capital contribution of the individual partners.
Any residue is divided between the partners in the same proportion as they shared in profits (s.44 of the Partnership Act (PA) 1890).
If the assets are insufficient to meet debts, partners’ advances and capital repayments, then the deficiency has to be made good out of any profits held back from previous years, or out of partners’ capital, or by the partners individually in the proportion to which they were entitled to share in profits.
Applying these rules to the partnership in question, the first step is for the value of the partnership assets to be realised in order to pay off the debts owed to the various outside creditors. As stated, the partnership assets are worth £20,000 and it has debts to outside creditors of £7,000. As the value of the assets is sufficient to cover all of these debts, the creditors will be paid their debts in full before any allocation between the partners.
The next stage in the problem is to consider Geo’s advance of £3,000 to the partnership and as stated above he is entitled to receive repayment of that sum before any further distribution to the partners. The effect of these payments is that amount left for distribution between the partners is only £10,000 (£20,000 less £7,000 to the outside creditors, less the £3,000 advance owed to Geo). This means that the partnership has actually suffered a loss of £30,000 on the original capital contributed by the members. That total loss will be allocated, according to the partnership agreement, in proportion to the capital contribution. As the total capital contribution was £40,000, Geo who provided £20,000 must suffer half of the loss (i.e. 20/40ths), Ho, who provided £12,000 must suffer 3/10ths of the loss (i.e. 12/40ths) and Io, who provided £8,000, will suffer 1/5th of the loss (i.e. 8/40ths). In terms of money, the losses will be: £15,000 for Geo, £9,000 for Ho and £6,000 for Io.
In practice these losses will merely reduce the amount of capital returned to the partners. Thus Geo will receive £5,000, Ho will receive £3,000 and Io will receive £2,000. |
