3. Dissolution and Winding Up

DISSOLUTION AND WINDING UP

Dissolution is the change in the relation of the partners caused by any partner ceasing to be associated in the carrying on of the business; partnership is not terminated but continues until the winding up of partnership affairs is completed. (Art. 1828¹)

Winding up is the process of settling the business or partnership affairs after dissolution, which includes the paying of previous obligations, collecting of assets previously demandable.

Termination is that point when all partnership affairs are completely wound up and finally settled. It signifies the end of the partnership life.

Causes of Dissolution (Art. 1830)

• Without violation of the agreement between the partners
• By the termination of the definite term/ particular undertaking specified in the agreement
• By the express will of any partner, who must act in good faith, when no definite term or particular undertaking is specified
• By the express will of all the partners who have not assigned their interests or had them charged for their separate debts, either before or after the termination of any specified term or particular undertaking
• By the bona fide expulsion of any partner from the business in accordance with power conferred by the agreement
• In contravention of the agreement between the partners, where the circumstances do not permit a dissolution under any other provision of Article 1830³, by the express will of any partner at any time
• By any event which makes it unlawful for business to be carried on/for the members to carry it on for the partnership
• Loss of specific thing promised by partner before its delivery
• Death of any partner
• Insolvency of a partner/partnership
• Civil interdiction of any partner
• Decree of court under Art. 1831⁴.

If neither a definite term nor a particular undertaking is specified, any partner may dissolve the partnership by express will, but must act in good faith. However, such partner must be in good faith, otherwise, he will be liable for damages. Among partners, mutual agency arises and the doctrine of delectus personae allows them to have the power, but not necessarily the right, to dissolve the partnership (Ortega v. Court of Appeals, G.R. No. 109248, 3 July 1995)⁵.

Grounds for dissolution by decree of court (Art. 1831):

• Partner declared insane in any judicial proceeding or shown to be of unsound mind
• Incapacity of partner to perform his part of the partnership contract
• Willful or persistent breach of partnership agreement or conduct which makes it reasonably impracticable to carry on partnership with him
• Business can only be carried on at a loss
• Other circumstances which render dissolution equitable
• Upon application by purchaser of partner's interest:
• After termination of specified term/particular undertaking
• Anytime if partnership at will when interest was assigned/charging order issued

Authority of Partner to Bind Partnership

General rule: Authority of partners to bind partnership is terminated. (Art. 1832)⁶

Exceptions:

• To wind up partnership affairs
• Complete transactions not finished (Art. 1834⁷)

(a) With respect to Partners (Art. 1833)

The authority of partners to bind the partnership through a new contract terminates immediately if the dissolution is not caused by the act, death, or insolvency of a partner.

Where the dissolution results from an act, death, or insolvency, the authority of a partner to act for the partnership terminates as between the partners under the following circumstances:

• If the cause is an act of a partner, the acting partner has knowledge of the dissolution; and
• If the cause is death or insolvency, the acting partner has knowledge or notice of such dissolution.

Qualifications

(b) With respect to Persons not Partners (Art. 1834⁸)

Partner continues to bind partnership even after dissolution in following cases:

• Transactions in connection to winding up partnership affairs/completing unfinished transactions
• Transactions which would bind partnership if not dissolved, when the other party/obligee:

Situation 1

• Had extended credit to partnership prior to dissolution, and
• Had no knowledge/notice of dissolution; or

Situation 2

• Did not extend credit to partnership prior to dissolution
• Had known partnership prior to dissolution
• Had no knowledge/notice of dissolution/fact of dissolution not advertised in a newspaper of general circulation in the place where partnership is regularly carried on

Post Dissolution (Art. 1834)⁹

Partner cannot bind the partnership after dissolution in the following cases:

• Where dissolution is due to unlawfulness to carry on with business (except: winding up of partnership affairs)
• Where partner has become insolvent
• Where partner unauthorized to wind up partnership affairs, except for the qualifying transactions described above

Rights of Partners upon Dissolution

General rule: Dissolution does not discharge existing liability of partner

Dissolution of Limited Partnership

• Priority in Distribution of Assets
• Those due to creditors, in the order of priority provided by law, except claims of limited partners on account of their contributions and claims due to general partners
• Those due to limited partners in respect of their share in profits/compensation
• Those due to limited partners of return of capital contributed
• Those due to general partner other than capital and profits
• Those due to general partner in respect to profits
• Those due to general partner for return of capital contributed (Art. 1863)¹⁰

Exceptions: Except by agreement.

• A partner is discharged from an existing liability upon an agreement to that effect among the partner, the partnership creditor, and the person or partnership continuing the business. The agreement may be inferred from the course of dealing between the creditor having knowledge of the dissolution and the person or partnership continuing the business (Art. 1835)¹¹

1. Rights of Partner where Dissolution not in Contravention of Agreement (Art. 1837)

• Apply partnership property to discharge liabilities of partnership
• Apply surplus, if any to pay in cash the net amount owed to partners

2. Rights of Partner where Dissolution in Contravention of Agreement (Art. 1837)

(a) Partner who did not cause dissolution wrongfully

• Apply partnership property to discharge liabilities of partnership
• Apply surplus, if any to pay in cash the net amount owed to partners
• Indemnity for damages caused by partner guilty of wrongful dissolution
• Continue business in same name during agreed term
• Possess partnership property if business is continued

(b) Partner who wrongly caused dissolution

• If business not continued by others
• Apply partnership property to discharge liabilities of partnership
• Receive in cash his share of surplus less damages caused by his wrongful dissolution
• If business continued by others
• Have the value of his interest at time of dissolution ascertained and paid in cash/secured by bond
• Be released from existing partnership liabilities through payment or an agreement with creditors under Article 1835

3. Rights of Injured Partner where Partnership Contract is Rescinded on Ground of Fraud/Misrepresentation by One Party (Art. 1838)¹³

• Right to lien on surplus of partnership property after satisfying partnership liabilities
• Right to subrogation in place of creditors after payment of partnership liabilities
• Right of indemnification by guilty partner against all partnership debts & liabilities

4. Settlement of Accounts between Partners

Assets of the partnership

• Partnership property (including goodwill)
• Contributions of the partners (Art. 1839 [1]¹⁴)

Order of Application of Assets

• Partnership creditors
• Partners as creditors
• Partners as investors—return of capital contribution
• Partners as investors—share of profits if any (Art. 1839 [2]¹⁵)

The partners will contribute the amount necessary to satisfy the liabilities based on the rules for distribution of profits and losses in Art. 1797¹⁶ (Art. 1839 [4]¹⁷). Even the individual property of a deceased partner shall be liable for such contributions (Art. 1839 [7]¹⁸).

When Business of Dissolved Partnership is Continued

Effects:

• Creditors of old partnership are also creditors of the new partnership, which continues the business of the old one w/o liquidation of the partnership affairs (Art.1840)¹⁹
• Creditors of the dissolved partnership have priority over the retired or deceased partner’s claim against the person or partnership continuing the business, including a claim for consideration promised for that partner’s interest (Art. 1840)²⁰

The retired or deceased partner or his legal representatives may

• Have the value of his interest ascertained as of the date of dissolution
• May receive as ordinary creditor the value of his share in the dissolved partnership with interest or profits attributable to use of his right, at his option (Art. 1841)²¹

Persons Authorized to Wind Up

• Partners designated by the agreement
• In absence of agreement, all partners who have not wrongfully dissolved the partnership
• Legal representative of last surviving partner (Art. 1836)²²

Unless otherwise agreed, the partners who have not wrongfully dissolved the partnership or the legal representative of the last surviving partner, not insolvent, has the right to wind up the partnership affairs, provided, however, that any partner, his legal representative or his assignee, upon cause shown, may obtain winding up by the court (Primelink Properties and Development Corporation and Rafaelito W. Lopez v. Lazatin-Magat, G.R. No. 167379, 27 June 2006)²³.

A partner’s share cannot be returned without first dissolving and liquidating the business for the partnership’s outside creditors have preference over the enterprise’s assets. The firm’s property cannot be diminished to their prejudice. (Magdusa v. Albaran, G.R. No. L-17526, 30 June 1962)²⁴

Due to its separate juridical personality from the individual partners, it is thus the partnership – having been the recipient of the capital contributions – which must refund the equity of retiring partners. Such duty does not pertain to partners who managed the business. The amount to be refunded consistent with the partnership being a separate and distinct entity, must necessarily be limited to the firm’s total resources. It can only pay out what it has for its total assets. But this is subject to the priority enjoyed by outside creditors. “After all the (said) creditors have been paid, whatever is left of the partnership assets becomes available for the payment of partners’ shares. (Villareal v. Ramirez, G.R. No. 144214, 14 July 2003)²⁵