When the Partnership Bubble Bursts: What happens if I want to continue operating the business post-dissolution?

Much like a divorce, the dissolution of a business partnership can be unexpected and difficult to manage. We have written before about what happens when someone leaves a partnership. This article goes into a bit more depth about what happens if you wish to continue operating the business after your business partner leaves.

If your partner has told you that they are leaving the partnership, you face several difficult questions concerning the future of your business. First, as the remaining partner/s, you must decide whether you will continue to operate the business which may mean ‘buying out’ the ‘outgoing’ partner/s or whether you will wind up the partnership and divide up the business’ assets between the partners.

If you choose to continue the business, two further questions arise: first, whether the ‘outgoing’ parties are entitled to lay claim to any post-dissolution partnership profits and second, whether the remaining partner/s can be remunerated for continuing to operate the business during the account settling phase.

While it seems only fair that the remaining partner/s should be entitled to all of the profits made without the outgoing partner/s, the law provides otherwise in some circumstances. A failure to understand what you can (and cannot) do if you continue to operate the business, may mean that your former partner/s have a claim to your hard-earned profits. It may also surprise some that the ordinary restrictions on partner remuneration may not apply during a dissolution. Read on to see how these issues apply to your partnership …

When has my partnership come to an end?

A commercial partnership usually ends when the entities involved in the partnership change.

The proper mechanism to change the composition of a partnership will be provided for in the Partnership Agreement (if there is one), or through one or more partners giving formal ‘notice’ of their intention to either dissolve, or ‘retire’ from, the partnership in accordance with the relevant State legislation. Other situations in which a partnership can be dissolved or come to an end can be found here.

The result in any case is (usually) the same, the partner/s will continue to administer the business until its assets and liabilities have been appropriately dealt with. In most cases, this simply means that the remaining partner/s will negotiate to purchase the outgoing partner’s share of the assets for their new venture.

The date of dissolution (the Dissolution Date) is usually the date agreed by the partners or the date upon which one of the mechanisms contained within the applicable State Act is engaged by the partners.

Ultimately, the best way to protect your interests is to be pre-emptive. Ideally, a Partnership Agreement should be put in place before commencing the business. This agreement should adequately provide for ways to deal with disagreement between the partners.

We strongly recommend that anyone who enters into a commercial partnership prepares a Partnership Agreement to minimise the risk of problems arising during the winding up of your business. If you would like to speak someone about preparing or updating a Partnership Agreement, call us on 1300 654 590.

Can my former partner claim profits from the business after dissolution?

Outgoing partners are entitled to a share of post-dissolution profits attributable to the use of the outgoing partner’s share of the partnership assets. Alternatively, they may be otherwise entitled to interest on the value of their share of the partnership assets.1

In practice, an outgoing partner would seek interest (over profits) where the partnership generates a net loss for the most recent period. This is calculated as simple interest (as opposed to compound interest) and is a mutually exclusive option to profit sharing.

In cases where an outgoing partner/s claims a share of profits, the responding party (i.e., the remaining partner/s) must prove that the business’ profits were generated by means other than the utilisation of partnership assets.2

By this point you are probably thinking this scheme is very unfair. After all, what if my former partner decides to leave the partnership and take up skiing in the Alps while I do all the work? Thankfully, the law agrees.

Outgoing partners may only rely upon this provision in cases where the remaining partners are misusing the outgoing partner’s share of the partnership assets (e.g., treating them as their own) or using them in such a way that could not be reasonably considered as part of the ‘ongoing administration of the partnership’ during its dissolution. These claimants are also limited in that, once a ‘buy out’ arrangement is agreed upon, they are no longer allowed to claim any interest in the new partnership.

While classifying an activity as merely ‘administration’ of an old partnership is only possible on a fact-by-fact basis, a good rule of thumb is to ask whether the ongoing usage of the assets is preserving the partnership’s value during the interim period of negotiations. In other words, can you be said to have maintained (or expanded) the pie that is to be divided between the various former partners once a ‘buy out’ is agreed to?

Can I seek remuneration for my continued services to the former partnership?

As a business owner, you may be aware of the rule against partners receiving remuneration for acting in the partnership business.3 The idea is that partners (in unincorporated partnerships) are generally prohibited from ‘profiting from themselves’ (i.e., through a contract of partnership).4 In essence, partners cannot receive a salary or wage.

However, the Courts see little point in preventing people from receiving a ‘proper allowance’ for conducting the business during its winding-up phase.5 Afterall, the value of the business assets may require their continual upkeep. For example, if you previously operated a cattle farm under a partnership, the livestock would need to be fed during the post-dissolution phase for there to be any assets left to divide once an agreement is reached.

In Australia, remaining partners are generally entitled to remuneration for their contributions to post-dissolution ‘partnership affairs’.6 In one case, a claimant in NSW was entitled to an hourly wage of $30 applied to ‘appropriate records of his time’, as well as reimbursement for paying stockmen, purchases of chicken litter, and medication for cattle. The payment of consultancy fees was also allowed; however, a division of these amounts was applied by the Court to account for each partner’s share in the business. This was despite the outgoing partner’s continued (but minor) business contributions during the account settling phase.

Remaining partners who decide to continue operating the business need to be careful when asserting an entitlement to remuneration for post-dissolution activities. It is important to keep in mind that the activities being relied upon on the issue of recompense must be related to the activities of the former partnership.

In other words, activities that fall outside the scope of the previous partnership (e.g., subsequent engagements with third parties) are not relevant to a discussion of remuneration.

Next steps

If your business partner has told you that they wish to leave the business, it’s time to start thinking about whether or not you want to continue operating or wind the business up. If you would like to speak to someone about Partnership Agreements or Ending a Partnership, contact us on 1300 654 590 or by email.

1 These range between 5% to 7% from State to State.

2 Manley v Sartori [1927] 1 Ch 157 [166] (Romer J).

3 Partnership Act 1892 (NSW) s 24(6).

4 Doctrine of Mutuality.

5 See e.g., Meyer & Co v Faber [1923] 2 Ch 421 [450]-[451] (Younger LJ); Harris v Sleep (1897) 2 Ch 80 (Lindley LJ).

6 Beale v Trinkler [2009] NSWSC 1093 [41] (Macready AJ).

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