Partnership: Dissolution and Winding Up (Arts. 1828-1842)

CHAPTER 3

Dissolution and Winding Up

Sources of provisions.

“The provisions on ‘Dissolution and Winding Up’ (Arts. 1828-1842.) were adopted, with suitable modifications, from the Uniform Partnership Act.
It was considered advisable to do so because these provisions are ample and comprehensive on the subject, while the lone provision of the present Civil Code 1 (Art. 1708.) that ‘The partition among the partners shall be governed by the rules for the partition of inheritances, with regard to its form as well as the obligations arising therefrom,’ is deemed unsatisfactory there being no similarity between a partnership and an inheritance.” (Report of the Code Commission, p. 149.)

Article 1828.

The dissolution of a partnership

is the change in the relation of the partners

caused by any partner ceasing

to be associated in the carrying on

as distinguished from the winding up of the business.

Effects of change in membership of a partnership.

Dissolution of existing partnership and formation of a new one.

Any change in the membership of a partnership, either by the retirement or death of partner, or by the admission of new members into the partnership, produces, technically, an immediate dissolution of the existing partnership relation, and the formation of a new one, although common business usage speaks of the admission of a partner to a firm and regards the firm as subsisting so long as the course of its business is not materially interrupted.

Transformation of all partners into incoming partners.

Therefore, strictly and technically speaking, there is no such thing as “incoming partner,” or “the admission of a person into an existing firm.”
All persons forming the new partnership upon the admission of the new person into the business are “incoming partners,” even though the same business had theretofore been conducted by the others through the medium of partnership.

Note that the admission of a new partner into an existing partnership which has the effect of dissolving the partnership (see Art. 1840[1].) is not “caused by any partner ceasing to be associated in the carrying on as distinguished from the winding up of the business.”
This “change in the relation of the partners” causes the dissolution which, in turn, results in the old partners ceasing to be associated in carrying on of the business of the dissolved partnership, and if the business is continued without liquidation, a new partnership comes into being composed of the old partners and the new partner. The definition in Article 1825 is thus not broad enough to cover this kind of dissolution resulting from the admission of a new partner.

Continuance by remaining partners of partnership as before.

A partnership is a contractual and fiduciary relation dependent upon the personality of its members, and the withdrawal or admission of a member changes so radically the contractual rights and duties inter se as to produce essentially a new relation, even though the parties contemplate no actual dissolution of the firm and continue to carry on business under the original articles of partnership and with the same account books. (40 Am. Jur. 267; see Art. 1840.)
In other words, the change in the relation of the partners will dissolve the partnership but will not disturb the continuance by the remaining partners or by the existing and new partners of the business as before. (but see Art. 1814.)

Dissolution, winding up, and termination defined.

A partnership, of course, does not last forever. When it ends, it involves these three separate stages.
The above terms are often confused. As they are used:

Dissolution

The change in the relation of the partners caused by any partner ceasing to be associated in the carrying on of the business. (Art. 1828.)
It is that point in time when the partners cease to carry on the business together.
It represents the demise of a partnership. (68 C.J.S. 842.)
Thus, any time a partner leaves the business, the partnership is dissolved.

Winding up

It is the actual process of settling the business or partnership affairs after dissolution, involving the collection and distribution of partnership assets, payment of debts, and determination of the value of each partner’s interest in the partnership.
It is the final step after dissolution in the termination of the partnership.

Termination

It is that point in time when all partnership affairs are completely wound up and finally settled.
It signifies the end of the partnership life.
It takes place after both dissolution and winding up have occurred.

Article 1829.

On dissolution

the partnership is not terminated,

but continues until the winding up of partnership affairs is completed.

Effects of dissolution.

Partnership not terminated.

The dissolution of a partnership must not be understood in the absolute and strict sense so that at the termination of the object for which it was created the partnership is extinguished.
Dissolution does not automatically result in the termination of the legal personality of the partnership, or the cessation of his business, nor the relations of the partners among themselves who remain as co-partners until the partnership is terminated.

Partnership continues for a limited purpose.

After dissolution, a partnership is considered as maintaining a limited existence for the purpose of making good all outstanding engagements, of taking and settling all accounts, and collecting all the property, means and assets of the partnership existing at the time of its dissolution for the benefit of all interested.

Transaction of new business prohibited.

After dissolution, the partnership as a business enterprise remains viable only for the purpose of winding up its affairs.

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 partners’ interest.

Whether the remaining partners may be allowed to continue the business or require to terminate the business depends on the method and manner of dissolution. (Art. 1830.)
It is only after winding up is accomplished that the existence of the partnership is terminated.

Thus, dissolution refers to the change in partnership relation and not the actual cessation of the partnership business.
It is not necessarily followed by a winding up of partnership affairs. (see Arts. 1837, 1840.)
Dissolution of a partnership must be distinguished from a mere suspension in the conduct of its business or operations.

Article 1830.

Dissolution is caused:

(1) Without violation of the agreement between the partners:

(a) By the termination

of the definite term

or particular undertaking

specified in the agreement;

(b) By the express will of any partner,

who must act in good faith,

when no definite term or particular undertaking is specified;

who have not assigned their interests

or suffered them to be charged for their separate debts,

either before or after the termination

of any specified term or particular undertaking;

(d) By the expulsion of any partner

from the business bona fide

in accordance with such a power

conferred by the agreement between the partners;

(2) In contravention of the agreement between the partners,

where the circumstances do not permit a dissolution

under any other provision of this article,

by the express will of any partner at any time;

(3) By any event which makes it unlawful

for the business of the partnership

to be carried on

or for the members to carry it on in partnership;

(4) When a specific thing

which a partner had promised to contribute to the partnership,

perishes before the delivery;

in any case by the loss of the thing,

when the partner who contributed it

having reserved the ownership thereof,

has only transferred to the partnership

the use or enjoyment of the same;

but the partnership shall not be dissolved

by the loss of the thing

when it occurs after the partnership

has acquired the ownership thereof;

(5) By the death of any partner;

(6) By the insolvency of any partner or of the partnership;

(7) By the civil interdiction of any partner;

(8) By decree of court under the following article.

Causes of dissolution.

Statutory enumeration exclusive.

Articles 1830 and 1831 (infra.) provide for the causes of dissolution.
The events that cause dissolution of a partnership may be divided into four (4) categories:

act of the parties not in violation of their agreement;
act of the parties in violation of their agreement;
operation of law; and
court decree.

Other causes are provided in Article 1840.
Extrajudicial dissolution may be caused:

without violation of the agreement between the partners (No. 1.)
in contravention of said agreement. (No. 2.)

It may be:

voluntary

when caused by the will of one or more or all of the partners
(Nos. 1 and 2.)

involuntary

when brought about independently of the will of the partners or by operation of law.
(Nos. 3, 4, 5, 6, 7, and 8)

The voluntary dissolution of partnership may be effected:

extrajudicially (Nos. 1 to 7.)
judicially, that is, by decree of court. (No. 8, in relation to Art. 1831.)

It will be observed that the causes provided in Article 1830 result in the automatic dissolution of the partnership

Article 1840: In Article 1840, automatic dissolution also takes place when:

a new partner is admitted, or
when a partner retires, withdraws, or is expelled from the partnership.

Article 1831: There is no automatic dissolution which enumerates the grounds for the judicial dissolution of the partnership.
Article 1838: seems to recognize the right of a partner entitled to rescind on the ground of fraud or misrepresentation to ask for judicial dissolution. (see also Art. 1831[6].)

It has been held that the statutory enumeration of the causes of dissolution precludes dissolution for any other cause.
Note that once a partnership is dissolved, the same partners may form a new partnership to continue the business under the same terms.

Effect of sale or assignment by one partner of his entire interest in the partnership to a third person.

It does not ipso facto bring about the dissolution of the partnership.

See Article 1813.
The assignment merely provides a ground for the other partners to dissolve the partnership (Art. 1830[c]) or for the purchaser to petition for a judicial decree of dissolution. (Art. 1831, par. 2.)

That it produces dissolution may be inferred, however, from the definition of dissolution under Article 1828.
But the dissolution created in such case is only technical, and not actual, i.e., only in the sense that his connection with the partnership is terminated.
In practice, the Securities and Exchange Commission accepts for registration amended articles of partnership together with the deed of sale of the interest of the withdrawing partner.

Dissolution effected without violation of partnership agreement.

There are four ways by which a partnership may be dissolved without violation of the partnership agreement:

Termination of the definite term or particular undertaking.
By the express will of any partner.
By the express will of all the partners.
By expulsion of any partner.

Termination of the definite term or particular undertaking.

A partnership may be constituted for a fixed term or it may have for its object a specific undertaking. (Arts. 1785, 1783.)
After the expiration of the term or particular undertaking, the partnership is automatically dissolved without the partners extending the said term or continuing the undertaking. (see Art. 1785.)
The dissolution of the partnership will be but in pursuance of the agreement of the partners, which is the law between them. (Art. 1159.)
If after said expiration the partners continue the partnership without making a new agreement, the firm becomes a partnership at will. (see Art. 1785.)

By the express will of any partner.

A partnership at will, regardless of whether the business is profitable or unprofitable, may be dissolved at any time by any partner without the consent of his co-partners without breach of contract, provided, the said partner acts in good faith.
Here, each partner has both the power and the right to terminate the relation at any time. If there is bad faith, the dissolution is wrongful.
The existence of good faith will absolve the partner exercising the right to dissolve the partnership from liability for damages which result to his co-partners by reason of his action.

In a case, where the withdrawal of a partner has been spurred by “interpersonal conflict’’ among the partners, it would not be right to let any of the partners remain in the partnership under such an atmosphere of animosity and, certainly, not against their will. Indeed, for as long as the reason for withdrawal of a partner is not contrary to the dictates of justice and fairness, nor for the purpose of unduly causing harm and damage upon the partnership, bad faith cannot be said to characterize the act. In the context used in the law, bad faith is no different from its normal concept of a conscious and intentional design to do a wrongful act for a dishonest purpose or moral obliquity.

While the attendance of bad faith cannot prevent the dissolution of a partnership, it can result in liability for damages.

The guilty partner would be liable for wrongful dissolution as provided in Article 1837.

A violation of the partnership agreement by the exclusion of a partner from participation in the management of the business of the firm has been held to give the excluded partner the right to declare the partnership dissolved.
The partner who breaks off the partnership with an unfair design, or for selfish objects, discharges his co-partners from all liabilities to him but he does not thereby free himself from his obligations to them.

When he quits the partnership that he may buy for himself what the partnership has a right to purchase, or that he may make a profit for his own advantage and to their prejudice, he is answerable to the partnership for the loss and damage; and so, if he quits at an unreasonable time, which occasioned a deprivation of profit to the partnership, it is but right that he should repair and make good such loss.

By the express will of all the partners.

No particular form of agreement is necessary to dissolve a partnership by consent.
Such dissolution may be accomplished either by an express agreement or by words and acts implying an intention to dissolve.
The agreement to dissolve the partnership before the termination of the specified term or particular undertaking must be unanimous.

The majority alone cannot dissolve the partnership without breach of contract.

That the consent of the partners who have assigned their interests or suffered them to be charged for their separate debts (Art. 1814.) is not required to effect dissolution without breach of the partnership agreement.

They are not given the right to have a voice or vote in the dissolution of the partnership.
The remaining partners alone may dissolve the partnership.

By expulsion of any partner.

The expulsion has the effect of decreasing the number of the partners, hence, the dissolution.
The expulsion must be made in good faith, and strictly in accordance with the power conferred by the agreement between the partners.
This power may be vested in one partner exclusively.
The partner expelled in bad faith can claim damages.

Dissolution effected in contravention of partnership agreement.

Dissolution may be for any cause or reason.

Any partner may cause the dissolution of the partnership at any time without the consent of his co-partners for any reason which he deems sufficient by expressly withdrawing therefrom even though the partnership was entered into for a definite term or particular undertaking.
Dissolution of such a partnership is, however, a contravention of the agreement.

Legal effects of dissolution.

The withdrawing partner is liable for damages for unjustified dissolution but in no case can he be compelled to remain in the partnership.

With his withdrawal, the number of members is decreased; hence, its dissolution.

The legal effects of this dissolution are laid down in Article 1837, par. 2, Nos. 1, 2, and 3.
A partner guilty of wrongful dissolution is not given the right to wind up partnership affairs. (Art. 1836.)

But a minor cannot be guilty of wrongful dissolution since he has the legal right to avoid his contract.

Power of dissolution always exists.

No person can be compelled either to become a partner or to remain one.
The relation of partners is one of mutual agency.
The agency is such an intimate personal one that equity cannot enforce it even where the agreement provides that the partnership shall continue for a definite time.
The right of a partner to dissolve is inseparably incident to every partnership and there can be no indissoluble partnership.
Note that there is no such thing as an indissoluble partnership only in the sense that there always exists the power, as opposed to the right, of dissolution.
The doctrine of delectus personae allows the partners to have the power, although not necessarily the right, to dissolve the partnership.
An unjustified dissolution by a partner can subject him to a possible action for damages.

Business becomes unlawful.

Dissolution may be caused involuntarily when a supervening event makes the business itself of the partnership unlawful or makes it unlawful for the partners to carry it on together.

law makes the continuance of the business illegal;
declaration of war between countries of which the partners are respectively citizens

A partnership must have a lawful object or purpose. (see Art. 1770.)
The partners, however, can change the nature of their business and continue the partnership with the new business.

Example:

J is a partner in a law firm. Later on, J is appointed Judge of the Regional Trial Court. Under the law, a Judge of the Regional Trial Court is prohibited from engaging in the practice of law. In this case, it would be unlawful for J to continue as a partner in the law firm. His appointment dissolves the partnership of which he is a member.
Contracts of partnership are necessarily dissolved by a state of war between the countries where the respective parties are citizens or where they become alien enemies, or by a civil war, since in both cases commercial intercourse is rendered unlawful between the partners belonging to opposing sides. This rule is based upon consideration of public policy, and is not affected by the intention of the parties.

Loss of specific thing.

This provision of Article 1830 refers only to specific things.

Loss before delivery.
Loss after delivery.
Loss where only use or enjoyment contributed.

When the thing to be contributed is not specific, Articles 1786 (par. 1.) and 1788 shall govern.

Loss before delivery.

If the specific thing to be contributed by a partner is lost before delivery, the partnership is dissolved because there is no contribution inasmuch as the thing to be contributed cannot be substituted with another.
There is here a failure of a partner to fulfill his part of the obligation.

Loss after delivery.

If the loss occurred after the delivery of the thing promised, then the partnership is not dissolved, but it assumes the loss of the thing having acquired ownership thereof.
The partners may contribute additional capital to save the venture. (see Art. 1791.)

Loss where only use or enjoyment contributed. —

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 because in either case, the partner cannot fulfill his undertaking to make available the use of the specific thing contributed.
Here, the partner bears the loss and, therefore, he is considered in default with respect to his contribution. (Art. 1795, par. 1.)
Upon dissolution, the partners may demand for an accounting and liquidation.
The mere failure by a partner to contribute his share of capital pursuant to an agreement to form a partnership does not prevent the existence of a firm. (see Art. 1786.) Such failure may be waived by the other parties to the agreement.

Death of any partner.

The deceased partner ceases to be associated in the carrying of the business; hence, the ipso facto dissolution of the partnership by his death by operation of law.
The surviving partners have no authority to continue the business except so far as is necessary to wind up (see Art. 1836.) except as provided in Article 1833. (see Art. 1840[3].)
Status of partnership.

The subsequent legal status of a partnership dissolved by the death of a partner is that of a partnership in liquidation, and the only rights inherited by the heirs are those resulting from the said liquidation in favor of the deceased partner, and nothing more.
Before this liquidation is made, it is impossible to determine what rights or interests, if any, the deceased partner had.

Liquidation of its affairs.

The liquidation of its affairs is by law entrusted to the surviving partners, or to liquidators appointed by them and not to the administrator or executor of the deceased partner.

Continuation of business without liquidation.

A clause in the articles of co-partnership providing for the continuation of the firm notwithstanding the death of one of the partners is legal.
A view has been expressed that the death of one of the partners does not ipso facto dissolve the partnership when, by common agreement, the surviving partners and the heirs of the deceased decide to continue, the said agreement being in such case considered as a continuation of the original contract of partnership.

In such a case, however, there is a dissolution of the partnership without winding up, and a continuance of the business of the dissolved partnership by a new partnership, of which the surviving partners and the heirs of the deceased or executors are the members becoming liable as the old to the creditors of the firm. (see Art. 1840[3].)
It will be seen from the foregoing that it is possible to continue a partnership (actually, a new one) after the death of a partner, thereby increasing the usefulness of the partnership device, and decreasing its disadvantage as compared with the corporate firm.

Insolvency of any partner or of partnership.

The insolvency of the partner or of the partnership must be adjudged by a court.
The insolvency of a partner

subjects his interest in the partnership to the right of his creditors (see Art. 1814.) and makes it impossible for him to satisfy with his property partnership obligations to its creditors in the event that partnership assets have been exhausted. (see Art. 1816.)
Thus, by his insolvency, its credit is impaired.
An insolvent partner has no authority to act for the partnership nor the other partners to act for him. (Art. 1833.)

The insolvency of the partnership

renders its property in the hands of the partners liable for the satisfaction of partnership obligations resulting in their inability to continue the business, which practically amounts to a dissolution.
But the reconveyance by the assignee of the properties of the partnership pursuant to an order of the court after the termination of insolvency proceedings involving the partnership has the effect of restoring the partnership to its status quo.

Civil interdiction of any partner.

A partnership requires the capacity of the partners.
A person under civil interdiction (or civil death) cannot validly give consent (Art. 1327.), as his capacity to act is limited thereby.(Art. 38.)
Civil interdiction deprives the offender during the time of his sentence of the right to manage his property and dispose of such property by any act or any conveyance inter vivos. (Art. 34, Revised Penal Code.)
Surely, one who is without capacity to manage his own property should not be allowed to manage partnership property.

Right to expel a partner.

In the absence of an express agreement to that effect, there exists no right or power of any member, or even a majority of the members, to expel all other members of the firm at will.
Nor can they at will forfeit the share or interest of a member or members and compel him or them to quit the firm, even paying what is due him.
Partner guilty of extreme and gross faults.

Mere derelictions of a member, such as failure to pay his part of the expenses or to promptly and faithfully perform his part of the services agreed to, do not ipso facto forfeit his right, or even authorize a court to forfeit his right, to the common property or assets of the partnership.
There may be, however, extreme and gross faults which would work a forfeiture, especially where there was an extreme emergency for him to perform his duty, and to be prompt and faithful.

Industrial partner engaging in business for himself.

The law authorizes the capitalist partners to exclude from the firm an industrial partner who engages in business for himself without the express permission of the partnership. (Art. 1789.)

Power expressly given by agreement.

A power of expulsion of a partner may be expressly given by agreement.
The power is not validly exercised if it is shown to have been exercised unfairly and without regard to the general interest of the partnership.
In theory, such power must be understood to exist not for the benefit of any particular parties holding control of firm membership, but for the benefit of the whole partnership.
Therefore, it cannot be exercised merely to enable the continuing partners to appropriate to themselves the share of the expelled partner at a fixed value less than the true value.

Article 1831. On application by or for a partner the court shall decree a dissolution whenever:

(1) A partner has been declared insane in any judicial proceeding or is shown to be of unsound mind;

(2) A partner becomes in any other way incapable of performing his part of the partnership contract;

(3) A partner has been guilty of such conduct as tends to affect prejudicially the carrying on of the business;

(4) A partner wilfully or persistently commits a breach of the partnership agreement, or otherwise so conducts himself in matters relating to the partnership business that it is not reasonably practicable to carry on the business in partnership with him;

(5) The business of the partnership can only be carried on at a loss;

(6) Other circumstances render a dissolution equitable.

On the application of the purchaser of a partner's interest under article 1813 or 1814:

(1) After the termination of the specified term or particular undertaking;

(2) At any time if the partnership was a partnership at will when the interest was assigned or when the charging order was issued.

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Article 1832. Except so far as may be necessary to wind up partnership affairs or to complete transactions begun but not then finished, dissolution terminates all authority of any partner to act for the partnership:

(1) With respect to the partners,

(a) When the dissolution is not by the act, insolvency or death of a partner; or

(b) When the dissolution is by such act, insolvency or death of a partner, in cases where article 1833 so requires;

(2) With respect to persons not partners, as declared in article 1834.

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Article 1833. Where the dissolution is caused by the act, death or insolvency of a partner, each partner is liable to his co-partners for his share of any liability created by any partner acting for the partnership as if the partnership had not been dissolved unless:

(1) The dissolution being by act of any partner, the partner acting for the partnership had knowledge of the dissolution; or

(2) The dissolution being by the death or insolvency of a partner, the partner acting for the partnership had knowledge or notice of the death or insolvency.

Right of partner to contribution from co-partners.

The above article speaks of dissolution caused by the act, insolvency, or death of a partner.
Where a partner enters into a new contract with a third person after dissolution, the new contract generally will bind the partners. (Art. 1834, par. 1.) Each of them is liable for his share of any liability created by the acting partner as if the partnership had not been dissolved.

Authority of partners inter se to act for the partnership.

The authority of a partner as it affects his co-partners (not third persons) is not deemed terminated except in two instances, namely:

The cause of the dissolution is the act of a partner and the acting partner had knowledge of such dissolution;

designed to protect the remaining partner or partners who might continue to act for the partnership as a going concern, not having actual knowledge of the dissolution.

The cause of the dissolution is the death or insolvency of a partner and the acting partner had knowledge or notice of the death or insolvency.

discards the fiction that everybody is presumed to have knowledge of death or insolvency.

Knowledge or notice of cause of dissolution.

Dissolution by death or insolvency.

Under Article 1833, the authority of a partner to act for the partnership may still continue notwithstanding its dissolution. In the case of death, to hold that a partner acting for the partnership bona fide in ignorance of the death or his co-partners must assume the entire liability, even though all other partners are ignorant of the death of the partner, and even though such deceased partner was entirely inactive and may have resided at any distance from the actual place of business, is entirely unjust to the acting partner or partners.
What has been said of the death of a partner applies also to the bankruptcy of a partner. If there are a number of partners, and one of them becomes bankrupt, and another having no knowledge or notice of this fact makes a contract in the ordinary course of the business, there appears no reason why he should not be able to call on his other partners, not bankrupt or deceased, to contribute towards any loss which his separate estate may sustain on account of the contract.

Dissolution by court decree or resulting from unlawfulness.

No substantial problem exists where dissolution is brought about, for example, by court decree, since this brings actual notice of the dissolution to all of the partners nor is a problem presented where dissolution results from unlawfulness, since the general rules governing actions arising out of illegal transactions would control in such cases.

When a partner has knowledge or notice of a fact.

The Uniform Partnership Act defines the two terms as follows:

“A person has knowledge of a fact within the meaning of this Act not only when he has actual knowledge thereof, but also when he has knowledge of such other facts as in the circumstances show bad faith.”
“A person has notice of a fact within the meaning of this Act when the person who claims the benefit of the notice:

(a) States the fact to such person, or
(b) Delivers through the mail or by other means of communication, a written statement of the fact to such person or to a proper person at his place of business or residence.”

It must be noted that Article 1833 applies only if the contract of the partner binds the partnership. If the partnership is not bound (Art. 1834, par. 4.), only the acting partner is personally liable.

Example:

A, B, and C were partners. A informed B that the former was resigning or withdrawing 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 by C, A and B are bound to contribute their share of the liability as if the partnership had not been dissolved. To avoid being liable for his share of partnership liability arising after the dissolution, A should prove knowledge on the part of C that A had already dissolved the partnership at the time the contract was made.
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 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.
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.

Article 1834. After dissolution, a partner can bind the partnership, except as provided in the third paragraph of this article:

(1) By any act appropriate for winding up partnership affairs

or completing transactions unfinished at dissolution;

(2) By any transaction which would bind the partnership

if dissolution had not taken place, provided the other party to the transaction:

(a) Had extended credit to the partnership prior to dissolution

and had no knowledge or notice of the dissolution; or

(b) Though he had not so extended credit,

had nevertheless known of the partnership prior to dissolution,

and, having no knowledge or notice of dissolution,

the fact of dissolution had not been advertised in a newspaper of general circulation in the place (or in each place if more than one) at which the partnership business was regularly carried on.

The liability of a partner under the first paragraph, No. 2, shall be satisfied out of partnership assets alone when such partner had been prior to dissolution:

(1) Unknown as a partner to the person with whom the contract is made; and

(2) So far unknown and inactive in partnership affairs

that the business reputation of the partnership could not be said

to have been in any degree due to his connection with it.

The partnership is in no case bound by any act of a partner after dissolution:

(1) Where the partnership is dissolved because it is unlawful to carry on the business,

unless the act is appropriate for winding up partnership affairs; or

(2) Where the partner has become insolvent; or

(3) Where the partner has no authority to wind up partnership affairs;

except by a transaction with one who -

(a) Had extended credit to the partnership prior to dissolution

and had no knowledge or notice of his want of authority; or

(b) Had not extended credit to the partnership prior to dissolution,

and, having no knowledge or notice of his want of authority,

the fact of his want of authority has not been advertised in the manner provided for advertising the fact of dissolution in the first paragraph, No. 2 (b).

Nothing in this article shall affect the liability under article 1825 of any person who after dissolution represents himself or consents to another representing him as a partner in a partnership engaged in carrying on business.

Power of partner to bind dissolved partnership to third persons.

Article 1834 enumerates the cases when a partner continues to bind the partnership even after dissolution (par. 1, Nos. 1 and 2.) and the case when he cannot bind the partnership after dissolution. (par. 3, Nos. 1, 2, and 3.)

Where there is no notice to third persons of dissolution.

General Rule: Upon the dissolution of the partnership, as between themselves, the power of one partner to act and bind the others is effectively terminated. (Arts. 1832, 1833.)
Exception: But the authority of a partner may apparently continue as regards third persons on the assumption that the partnership is still existing.

Since a partnership once established is, in the absence of anything to indicate its termination, presumed to exist, the law, for the protection of innocent third persons, imposes upon partners the duty of giving notice of the dissolution of the partnership.

Where there is actual or constructive knowledge by third persons of dissolution.

The measure of the right of third persons who continue to deal with a dissolved partnership depends upon the question of whether they knew or should have known of the fact of dissolution.
If they did, the validity of their transactions is governed by the question whether those transactions were necessary to liquidate the partnership affairs.

Example:

Where A, B, and C are active and ostensible partners, A’s retirement terminates the actual authority of A, B, or C to impose new obligations on the partnership, except such as may be necessary to wind up the business or to complete transactions begun but not then finished.

Assume that D has extended credit to the partnership prior to A’s retirement, and has no knowledge of A’s retirement, and that no notice thereof has been communicated to X, by mail or otherwise, then on the ground of estoppel:

If B or C, purporting to act on behalf of the partnership, contracts with D (e.g., orders goods), the partnership (A, B, and C, jointly) is liable to D.
If A, purporting to act on behalf of the partnership, contracts with D, the partnership (A, B, and C, jointly) is liable to D. (Babb & Martin, op. cit., pp. 262-263.)

Notice of dissolution to creditors.

As to persons who extended credit to partnership prior to dissolution.

Customers of the partnership or persons who extended credit to the partnership prior to its dissolution must have knowledge or notice of the dissolution to relieve the partnership from liability.

As to persons who had known of partnership’s existence.

As to persons who had not so extended credit prior to its dissolution, but who had known of its existence, the fact that the dissolution had been published in the newspaper would be sufficient (par. 1, No. 2[a, b].), even if they did not actually read the advertisement.

Where acting partner has no authority to wind up partnership affairs.

Under the third paragraph, notice of dissolution is unnecessary except in case No. 3, where the partner has no authority to wind up partnership affairs. Third persons dealing with the partner without such authority are protected under the same circumstances mentioned in paragraph 1, No. (2)(a) and (b).

Where acting partner has become insolvent.

As to insolvency, the law makes a distinction between:

the right of a partner who has no knowledge or notice of the other partner’s insolvency to bind the partnership

recognized under Article 1833(2)
the innocent partner is protected in his continued right to make binding partnership agreements

the right of a third person to claim that his contract with the partnership is valid, notwithstanding its dissolution through insolvency of the partner with whom the contract was made

denied under Article 1834 (par. 3, No. 2.),
no similar protection is extended to a third party who innocently makes a contract with an insolvent partner because it is incumbent upon him to know the status of the insolvent partner

Where dissolution caused by death of a partner.

As to death, no such distinction is made, largely because the deceased partner no longer exists. Death, then, is not considered to be notice perse whether as to the surviving partner or as to third persons. (Teller, op. cit., pp. 104, 108.)

Character of notice required.

The character of notice required to relieve a retiring partner or the representatives of a deceased partner from subsequent liability on partnership obligations varies in accordance with the class of persons required to be notified.

As to prior dealers.

Notice must be actual.

Mere mailing of a letter to a former dealer is insufficient to relieve the retiring partner from subsequent liability, where the notice was never received.
Furthermore, there is no duty on the part of a prior dealer to inquire into the question of retirement, even though the prior dealer had the means of obtaining knowledge of such retirement but failed to make use of it.
So, it was held that a prior dealer entitled as such to actual notice, may not be said as a matter of law to have received notice by reason merely of the fact that the retirement was mentioned in a newspaper to which the prior dealer subscribed, or although the fact of dissolution was mentioned editorially in the local newspaper.

A prior or former dealer is one who has extended credit on the faith of the partnership, through confidence in the solvency and probity of the firm.

Mere dealing with a firm on a cash basis does not constitute one a prior dealer.
One who purchases goods from the supposed partnership is not a prior dealer.

As to all others.

Notice is accomplished by an advertisement in a local newspaper.

Actual notification is not necessary.
It should be noted, however, that the requirement of newspaper notice appears to exist only where the third party knew of the partnership prior to dissolution.
If he did not, he is entitled to no notice whatsoever.
It is not clear whether notice to others other than prior dealers, who had knowledge of the partnership prior to dissolution, was sufficient if given in ways other than by newspaper notification. Apparently, the law has made newspaper notification an exclusive method for giving notice.

Example:

Q: T purchased goods from a partnership. Thereafter, the partnership was dissolved. Notice of the dissolution was advertised in the local newspaper. Without knowledge of the dissolution, T thereafter extended credit to the supposed partnership at the request of one of its members in connection with a transaction not necessary for the liquidation of the business. May T hold the partnership liable on the transaction?

A: No. Prior dealers must be given actual notice of the dissolution of a partnership in order to prevent the continuance of partnership liability. T, however, is not a prior dealer. Hence, he is considered to have received notice as a matter of law when the fact of dissolution was advertised in the local newspaper.

Dormant partner need not give notice.

Under the second paragraph, the liability of a partner unknown as such to the person with whom the contract is made or so far unknown and inactive in partnership affairs shall be satisfied out of partnership assets alone.

This is a qualification of the rule that partners are liable pro rata with all their property after the assets of the partnership have been exhausted for partnership obligations. (Art. 1816.)

A dormant partner is both inactive and secret.

His connection with the partnership not having known, it cannot in any degree have contributed towards establishing its reputation or credit.

Third persons, not having dealt with the partnership in reliance upon the membership of the dormant partner, are accordingly not entitled to notice of his withdrawal.
The principle of estoppel cannot operate to continue his liability or his authority after dissolution since prior thereto, he was never known or held out as a partner.
He will, of course, be personally liable for partnership debts arising at the time of his retirement.

Partnership by estoppel after dissolution.

Article 1834 (last par.) touches upon the subject of partnership by estoppel (Art. 1825.), since a partnership is held to exist as to third persons though it does not exist as a going concern so far as the partners themselves are concerned.
The situation differs from a partnership by estoppel, however, in that a partnership did once exist and liability is based upon its continuance as a matter of law as far as third persons are concerned.
A partnership by estoppel involves a “holding out” by parties as partners when, in fact, they are not partners.

Article 1825 deals with partnership by estoppel. It will be seen that Article 1769(1) is not entirely accurate in stating that “Except as provided by Article 1825, persons who are not partners as to each other are not partners as to third persons,” since this overlooks the circumstances under which by virtue of Article 1834, third persons may claim the validity of contracts made with dissolved partnerships in disregard of the fact of dissolution.

Article 1835.

The dissolution of the partnership does not of itself discharge the existing liability of any partner.

A partner is discharged from any existing liability upon dissolution of the partnership by an agreement to that effect between himself, the partnership creditor and the person or partnership continuing the business; and such 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.

The individual property of a deceased partner shall be liable for all obligations of the partnership incurred while he was a partner, but subject to the prior payment of his separate debts.

Effect of dissolution on partner’s existing liability.

The dissolution of a partnership does not of itself discharge the existing liability of a partner.
A partner may be relieved from all existing liabilities upon dissolution only by an agreement to that effect between himself, the partnership creditor, and the other partners.
The consent, however, of the creditor and the other partners to the novation may be implied from their conduct.

Liability of estate of deceased partner.

In accordance with Article 1816, the individual property of a deceased partner shall be liable for all obligations of the partnership incurred while he was a partner.
Note that the individual creditors of the deceased partner are to be preferred over partnership creditors with respect to the separate property of said deceased partner. (Art. 1839[8].)

Example:

If A, B, and C are partners and Ar etires, all three (A, as well as B and C) continue to be personally liable for partnership debts existing at the time of A’s retirement.

Similarly, if A dies, his individual estate is available to partnership creditors, subject, however, to the claims of A’s personal creditors. Even an agreement among A, B, and C whereby B and C promised to assume the partnership debts does not release A, unless the creditors assent to such substitution of debtors, either by express agreement (novation) or by agreement inferable from course of dealing.

Article 1836.

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.

Manner of winding up.

The winding up of the dissolved partnership may be done either:

Judicially

under the control and direction of the proper court upon cause shown by any partner, his legal representative, or his assignee;

Extrajudicially

by the partners themselves without intervention of the court.

Nature of action for liquidation.

An action for the liquidation of a partnership is a personal one; hence, it may be brought in the place of residence of either the plaintiff or the defendant.
Thus, the fact that the plaintiff prays for the sale of the assets of the partnership including a fishpond located in a province other than that where the action was brought, does not change the nature or character of the action, such sale being merely a necessary incident to the liquidation of the partnership, which should precede and/or is a part of its proper liquidation.

Persons authorized to wind up.

The following are authorized to wind up the affairs of the partnership:

The partners designated by the agreement;
In the absence of such agreement, all the partners who have not wrongfully dissolved the partnership; or
The legal representative (executor or administrator) of the last surviving partner (when all the partners are already dead), not insolvent. (Art. 1830[6].)

The court may, in its discretion, after considering all the facts and circumstances of the particular case, appoint a receiver to wind up the partnership affairs where such step is shown to be to the best interests of all persons concerned.
An insolvent partner does not have the right to wind up partnership affairs. (see Arts. 1830[6]; 1833.)

Survivor’s right and duty to liquidate.

General Rule: When a member of a partnership dies, the duty of liquidating its affairs devolves upon the surviving member or members of the firm
Exception: Legal representative of the deceased partner, when such partner was the last surviving partner

The legal representative has no right to interfere with the partnership business, so long as the surviving partner proceeds in good faith to settle its affairs, and it makes no difference how well qualified such representative may be to assist. The executor or administrator of a deceased partner cannot insist on continuing the business in the absence of some controlling agreement to that effect.
Under the Uniform Partnership Act, “x x x a surviving partner is entitled to reasonable compensation for his services in winding up partnership affairs.” (Sec. 18[f] thereof.) Our law is silent on this point. It is believed, however, that even in the absence of agreement, the surviving partner or liquidating partner is entitled to reasonable compensation in exceptional situations as where the services rendered are extraordinary or substantial in nature.

Powers of liquidating partner.

Make new contracts.

For the purpose of winding up the partnership, a liquidating partner is sole agent of the partnership, but merely for that one specific purpose.
Thus, without express authorization, he cannot make new contracts or create new liabilities, as by giving promissory notes binding on the firm nor can he extend the time for the payment of existing obligations to the firm, or make acknowledgments of the validity of claims against the firm.

Raise money to pay partnership debts.

For the purpose of winding up the concern, however, the liquidating partner has the same general power to bind the firm as he had before, and he may bind the partnership by borrowing money to meet its accruing liabilities, and may sell its real estate to raise money to pay its debts.

Incur obligations to complete existing contracts or preserve partnership assets.

A liquidating partner has power to incur obligations necessary to the completion of existing contracts, and to incur debts or other obligations necessary for the reasonable preservation of partnership assets or in procuring a favorable market for their disposal.

Incur expenses necessary in the conduct of litigation.

Where a liquidating partner is confronted with the necessity of litigation in order to perform his duty in winding up the affairs of the partnership, he has power to employ an attorney, with resultant obligations, to prosecute and defend the action or to incur other expenses necessary in the conduct of such litigation. In other words, for the purpose of winding up the affairs of a dissolved partnership, the surviving partner has full authority to do every thing that may be necessary, but his power is limited to the performance of acts which are indispensable to that end.
The deceased partner’s estate is not liable for any subsequent debts or losses incurred by the surviving partners who continued the partnership business without the consent of the estate.

Article 1837.

When dissolution is caused in any way,

except in contravention of the partnership agreement,

each partner, as against his co-partners and all persons claiming through them in respect of their interests in the partnership, unless otherwise agreed,

may have the partnership property applied to discharge its liabilities,

and the surplus applied to pay in cash the net amount owing to the respective partners.

But if dissolution is caused by expulsion of a partner,

bona fide under the partnership agreement

and if the expelled partner is discharged from all partnership liabilities,

either by payment or agreement under the second paragraph of article 1835,

he shall receive in cash only the net amount due him from the partnership.

When dissolution is caused in contravention of the partnership agreement the rights of the partners shall be as follows:

(1) Each partner who has not caused dissolution wrongfully shall have:

(a) All the rights specified in the first paragraph of this article, and

(b) The right, as against each partner who has caused the dissolution wrongfully,

to damages breach of the agreement.

(2) The partners who have not caused the dissolution wrongfully,

if they all desire to continue the business in the same name

either by themselves or jointly with others,

may do so, during the agreed term for the partnership

and for that purpose may possess the partnership property,

provided they secure the payment by bond approved by the court,

or pay any partner who has caused the dissolution wrongfully,

the value of his interest in the partnership at the dissolution,

less any damages recoverable under the second paragraph, No. 1 (b) of this article,

and in like manner indemnify him against all present or future partnership liabilities.

(3) A partner who has caused the dissolution wrongfully shall have:

(a) If the business is not continued under the provisions of the second paragraph, No. 2,

all the rights of a partner under the first paragraph,

subject to liability for damages in the second paragraph, No. 1 (b), of this article.

(b) If the business is continued under the second paragraph, No. 2, of this article,

the right as against his co-partners and all claiming through them in respect of their interests in the partnership,

to have the value of his interest in the partnership,

less any damage caused to his co-partners by the dissolution,

ascertained and paid to him in cash,

or the payment secured by a bond approved by the court,

and to be released from all existing liabilities of the partnership;

but in ascertaining the value of the partner's interest the value of the good-will of the business shall not be considered.

Right of partner to application of partnership property on dissolution.

The liquidation of the assets of the partnership following its dissolution is governed by various provisions of the Civil Code such as Article 1837.
However, an agreement of the partners, like any other contract, is binding among them and normally takes precedence to the extent applicable over the general provisions of the Civil Code.
The objectives of Article 1837 are, in the main:

to provide for the payment of the partner who leaves the firm, and
to indemnify him against existing or possible future liability.

“Partner’s lien”

The right of every partner, on a dissolution, against the other partners and persons claiming through them in respect of their interests as partners, to have the partnership property applied to discharge partnership liabilities and the surplus assets, if any, distributed in cash to the respective partners, after deducting what may be due to the firm from them as partners.
The extent of this right depends on whether the dissolution is caused without violation of the partnership agreement, or in violation of the partnership agreement. The guilty partner is given by law certain rights.

Rights where dissolution not in contravention of agreement.

Unless otherwise agreed, the rights of each partner in case of dissolution without violation of partnership agreement are as follows:

To have the partnership property applied to discharge the liabilities of the partnership; and
To have the surplus, if any, applied to pay in cash the net amount owing to the respective partners.

When the dissolution is caused by expulsion of a partner bona fide (so without violation of the partnership agreement), such expelled partner may be discharged from all partnership liabilities either by payment or by an agreement between him, the partnership creditors, and the other partners. (Art. 1835.)

He shall have the right only to receive in cash the net amount due him from the partnership.

If the dissolution is proper or rightful, no partner is liable for any loss sustained as a result of the dissolution.

Rights where dissolution in contravention of agreement.

When the partnership is dissolved in violation of the partnership agreement, the rights of a partner vary depending upon whether he is the innocent or the guilty partner.

Rights of partner who has not caused the dissolution wrongfully:

To have partnership property applied for the payment of its liabilities and to receive in cash his share of the surplus;
To be indemnified for damages caused by the partner guilty of wrongful dissolution;
To continue the business in the same name during the agreed term of the partnership, by themselves or jointly with others; and
To possess partnership property should they decide to continue the business.

Rights of partner who has wrongfully caused the dissolution:

If the business is not continued by the other partners, to have the partnership property applied to discharge its liabilities and to receive in cash his share of the surplus less damages caused by his wrongful dissolution.
If the business is continued:

To have the value of his interest in the partnership at the time of the dissolution, less any damage caused by the dissolution to his co-partners, ascertained and paid in cash or secured by bond approved by the court; and
To be released from all existing and future liabilities of the partnership.

Note that the innocent partners have more rights than the guilty partners and that the latter are made liable for damages caused by their wrongful dissolution, and in ascertaining the value of their interest, the value of the goodwill of the business is not considered, obviously as a penalty for their bad faith.
If the innocent partners decide to buy the guilty partner’s interest, they may continue the partnership business in the same firm name.

The guilty partner is entitled to his share of the appraised value of the business less the damages recoverable by the innocent partners.
If they decide otherwise, they may wind up the partnership business.

Goodwill of a business.

The goodwill of a business may be defined to be the advantage which it has from its establishment or from the patronage of its customers, over and above the mere value of its property and capital.
The goodwill of a partnership rests in the probability that its old customers will continue their custom and will commend the partnership to others, making the latter new customers.
It may also include the advantages which may be derived from the partners holding themselves out as carrying on the business identified with the name of a particular firm.

Goodwill as part of partnership assets.

Inasmuch as the word “assets” in the law of partnership is not to be confined to assets at law, but includes all assets applicable to the payment of the partnership debts, the goodwill of the partnership, if of money value, is usually considered part of the property and assets of the firm, in the absence of a contract, express or implied, to the contrary.

Firm name as part of goodwill.

The name of a firm is an important part of the goodwill and its use may be protected accordingly.
The firm name of the partnership, as distinguished from the name of an individual, is an element of the partnership enterprise, a substantial asset thereof, and passes with a sale of the partnership property and goodwill.
Being unquestionably partnership property, the representative of a deceased partner, therefore, is entitled to have an accounting of the value of the goodwill of the partnership and a partner may insist that upon dissolution, the goodwill should be sold as part of the partnership assets.

Existence of saleable goodwill.

The goodwill of a business is a proper subject of sale.
However, a saleable goodwill can exist only in a commercial partnership.
It cannot arise in a professional partnership, such as partnership of attorneys or physicians, the reputation of which depends on the individual skill or personal qualifications of its members.
Where the goodwill of the business is dependent solely on the skill or professional ability, reputation or standing of the partners (as attorneys, physicians) its goodwill is not subject to sale, and the name by which it is known may not be appropriated by any person to the exclusion of any other person.

Article 1838.

Where a partnership contract is rescinded

on the ground of the fraud or misrepresentation of one of the parties thereto,

the party entitled to rescind is, without prejudice to any other right, entitled:

(1) To a lien on, or right of retention of,

the surplus of the partnership property

after satisfying the partnership liabilities to third persons

for any sum of money paid by him for the purchase of an interest in the partnership

and for any capital or advances contributed by him;

(2) To stand,

after all liabilities to third persons have been satisfied,

in the place of the creditors of the partnership

for any payments made by him in respect of the partnership liabilities; and

(3) To be indemnified

by the person guilty of the fraud

or making the representation

against all debts and liabilities of the partnership.

Right of partner to rescind contract of partnership.

If one is induced by fraud or misrepresentation to become a partner, the contract is voidable or annullable. (Art. 1390[2].)
If the contract is annulled, the injured partner is entitled to restitution. (Art. 1398.) Here, the fraud or misrepresentation vitiates consent. (Art. 1330.)
However, until the partnership contract is annulled by a proper action in court, the partnership relations exist (Art. 1390.) and the defrauded partner is liable for all obligations to third persons.

Rights of injured partner where partnership contract rescinded.

This article speaks of the rights of the injured partner where the partnership contract is rescinded (should be “annulled”) on the ground of fraud or misrepresentation. They are as follows:

Right of a lien on, or retention of, the surplus of partnership property after satisfying partnership liabilities for any sum of money paid or contributed by him;
Right to subrogation in place of partnership creditors after payment of partnership liabilities; and
Right of indemnification by the guilty partner against all debts and liabilities of the partnership.

It is to be noted that the rights of the partner entitled to rescind (to annul) are without prejudice to any other rights under other provisions of law.

Article 1839.

In settling accounts between the partners after dissolution, the following rules shall be observed, subject to any agreement to the contrary:

(1) The assets of the partnership are:

(a) The partnership property,

(b) The contributions of the partners necessary for the payment of all the liabilities specified in No. 2.

(2) The liabilities of the partnership shall rank in order of payment, as follows:

(a) Those owing to creditors other than partners,

(b) Those owing to partners other than for capital and profits,

(d) Those owing to partners in respect of profits.

(3) The assets shall be applied in the order of their declaration in No. 1 of this article to the satisfaction of the liabilities.

(4) The partners shall contribute, as provided by article 1797, the amount necessary to satisfy the liabilities.

(5) An assignee for the benefit of creditors or any person appointed by the court shall have the right to enforce the contributions specified in the preceding number.

(6) Any partner or his legal representative shall have the right to enforce the contributions specified in No. 4, to the extent of the amount which he has paid in excess of his share of the liability.

(7) The individual property of a deceased partner shall be liable for the contributions specified in No. 4.

(8) When partnership property and the individual properties of the partners are in possession of a court for distribution, partnership creditors shall have priority on partnership property and separate creditors on individual property, saving the rights of lien or secured creditors.

(9) Where a partner has become insolvent or his estate is insolvent, the claims against his separate property shall rank in the following order:

(a) Those owing to separate creditors;

(b) Those owing to partnership creditors;

Liquidation and distribution of assets of dissolved partnership.

The process of winding up, where the business of the dissolved partnership is not continued, consists in liquidating partnership property (turning it into cash), paying outstanding debts, collecting outstanding receivables, distributing the proceeds, and any other actions required to bring partnership business to a close.

Until the partnership accounts are determined, it cannot be determined how much any of the partners is entitled, if at all.
Partners severally have the implied authority to sell partnership property and to collect obligations due to the partnership.
These powers may be delegated to one or more of their number as liquidating partner or partners.

The law, however, does not require a partnership to convert all its assets into cash before making a distribution to the partners.
It is within the power of the court to order a distribution of its assets in cash, property, or a combination of both.
Property which may be made available for distribution includes, in addition to the partnership property, contributions which may be collected from the partners so far as may be necessary for the payment of partnership obligations to creditors and to partners.
“equitable lien” or “quasi-lien”

A partner has a right to have debts owing to the partnership from his co-partners deducted from their respective shares. This right is called “equitable lien” or “quasi-lien” in American law. It exists only when the affairs of the partnership are rounded up and the shares of the partners are computed after dissolution.

“partner’s lien law”

Each partner is entitled to a share in the surplus property of the partnership, if any, in proportion to his interest in the partnership. (see Art. 1812.) This rule is called the “partner’s lien law” in American law.

Rules in settling accounts between partners after dissolution.

Article 1839 sets forth a priority system for the distribution of partnership property (see Art. 1810.) and individual property when a partnership is dissolved to those entitled thereto.
The following rules as to distribution are subject to variation by agreement of the partners, either in their original partnership agreement or in a dissolution agreement, subject to the rights of partnership creditors.

Assets of the partnership.

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

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:

First, those owing to partnership creditors;
Second, those owing to partners other than for capital and profits such as loans given by the partners or advances for business expenses;
Third, those owing for the return of the capital contributed by the partners; and
Finally, if any partnership assets remain, they are distributed as profits to the partners in the proportion in which profits are to be shared.

Loans and advances made by partners.

Loans and advances made by partners to the partnership are not capital. Nor are undivided profits, unless otherwise agreed.
Capital contributions are returnable only on dissolution, but loans are payable at maturity and accumulated profits may be withdrawn at any time by consent of a majority.
Amounts paid into the partnership in excess of a partner’s agreed capital contributions constitute loans or advances which draw interest on which they are made. Accumulated profits do not draw interest, as they are not regarded as loans and advances merely because they are left with the firm.

Capital contributed by partners.

Capital represents a debt of the firm to the contributing partners.
If, on dissolution, partnership assets are insufficient to repay capital investments, the deficit is a capital loss which requires contribution like any other loss.

The return of the amount equivalent to the capital contribution of each partner shall be increased by his share of undistributed profits or decreased by his share of net losses.

General Rule: A partner who furnishes no capital but contributes merely his skill and services is not entitled to any part of the firm capital on dissolution.
Exception: Agreement provides otherwise.

He must look for his compensation to his share of the profits remaining after repayment of the capital to the contributors.

The total capital contribution of the partners is not equivalent to the gross assets to be distributed to the partners at the time of the dissolution of the partnership.

It may be impaired or become unavailable for distribution or return to the partners because of losses sustained by the partnership.

Right of a partner where assets insufficient.

If the assets enumerated in No. 1 are insufficient (i.e., there is an overall loss), the deficit is a capital loss which requires contribution like any other loss.
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.
If any of the partners does not pay his share of the loss, the remaining partners have to pay but they can sue the non-paying partner for indemnification.

Liability of deceased partner’s individual property.

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

Priority to payment of partnership creditors/partners’ 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 [The Insolvency Law], as amended.)
Neither class of creditors is allowed to trespass on the fund belonging to the other until the claims of that other shall have been satisfied. Stated otherwise, the general rule is: “Partnership assets to partnership creditors, individual assets to individual creditors; anything left from either goes to the other.”
It involves the ranking of assets in a certain order toward the payment of outstanding debts. This rule is known as the doctrine of the marshalling of assets.
In an American case, it was held that the United States does not have the right to be paid its income taxes due from individual partners out of the assets of a bankrupt firm in preference to the claim of partnership creditors. In line with the rule is the second paragraph of Article 1835.
Suppose one is a creditor of all the partners solidarily on a transaction independent of the partnership, may he, under the bankruptcy law, share pari passu with the partnership creditors in its assets? No. This is so even though both the partnership and its members are in bankruptcy. Having secured priority over the firm creditors against the individual property of the firm members, the creditors are relegated to a secondary position to the firm creditors, since the claim is not based on a firm obligation.
Furthermore, partnership is regarded as a legal entity separate and distinct from its members.

Distribution of property of insolvent partner.

If a partner is insolvent, his individual property shall be distributed as follows:

First, to those owing to separate creditors;
Then, to those owing to partnership creditors; and
Lastly, to those owing to partners by way of contribution.

The preference of the individual creditors of a partner in the distribution of his separate estate results, as a principle of equity, from the preference of partnership creditors in the partnership funds.
The separate creditor of an individual partner can execute against the assets of the firm only to the extent of the interest of the partner in the firm assets, which is nothing more than a right to any surplus remaining after firm creditors have been paid.

Example:

A, B, and C, are partners. A contributed P150,000.00, B P100,000.00, and C, P50,000.00. On dissolution, the assets of the partnership amounted to P500,000.00. The partnership owes D the amount of P70,000.00, E, P50,000.00, and A, P20,000.00.
The accounts of the partnership shall be settled as follows:

D and E, who are partnership creditors, shall be paid first the total sum of P120,000.00, leaving a balance of P380,000.00;
Then, A, who is also a creditor, will be paid his credit of P20,000.00, leaving a balance of P360,000.00;
Afterwards, the contributions of A, B, and C to the partnership capital shall be returned to them in the total sum of P300,000.00, thereby leaving a balance of P60,000.00;
The balance of P60,000.00 constitutes the profit which shall be divided among A, B, and C (unless there is an agreement to the contrary [Art. 1839, 1st par.] which, however, cannot prejudice the rights of third persons) in proportion to their capital contributions. Therefore, A is entitled to 3/6 or P30,000.00, B, 2/6 or P20,000.00 and C, 1/6 or P10,000.00.

Suppose, in the same example, the liabilities of the partnership amount to P560,000.00. The partnership assets, then shall be exhausted to satisfy these liabilities thereby leaving an unpaid balance of P60,000.00. 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 P30,000.00, B, P20,000.00, and C, P10,000.00. These contributions which are necessary to pay the liabilities of the partnership are considered partnership assets (No. 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 P60,000.00, then, he has a right to recover the amount which he has paid in excess of his share of the liability from A, P30,000.00 and from B, P20,000.00.
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.
Suppose now that under Nos. 1 and 2 above, C owes F P40,000.00. Following the rule that partnership creditors have preference regarding partnership property, only the share of C in the amount of P10,000.00 can be used to pay his debt to F and the unpaid balance of P30,000.00 must be taken from the individual property, if any, of C.
Suppose again, that the partnership debts amount to P560,000.00 as in No. 3. So, C is still liable out of his separate property to partnership creditors in the amount of P10,000.00. His separate property amounts to P45,000.00. In this case, his assets shall first be applied to pay his debt of P40,000.00 to F and the balance of P5,000.00 to pay part of his debt of P10,000.00 still owing to partnership creditors in accordance with the rule that regarding individual properties, individual creditors are preferred.

Article 1840.

In the following cases creditors of the dissolved partnership

are also creditors of the person or partnership continuing the business:

(1) When any new partner is admitted into an existing partnership,

or when any partner retires and assigns (or the representative of the deceased partner assigns) his rights in partnership property to two or more of the partners, or to one or more of the partners and one or more third persons, if the business is continued without liquidation of the partnership affairs;

(2) When all but one partner retire and assign (or the representative of a deceased partner assigns) their rights in partnership property to the remaining partner, who continues the business without liquidation of partnership affairs, either alone or with others;

(3) When any partner retires or dies and the business of the dissolved partnership is continued as set forth in Nos. 1 and 2 of this article, with the consent of the retired partners or the representative of the deceased partner, but without any assignment of his right in partnership property;

(4) When all the partners or their representatives assign their rights in partnership property to one or more third persons who promise to pay the debts and who continue the business of the dissolved partnership;

(5) When any partner wrongfully causes a dissolution and the remaining partners continue the business under the provisions of article 1837, second paragraph, No. 2, either alone or with others, and without liquidation of the partnership affairs;

(6) When a partner is expelled and the remaining partners continue the business either alone or with others without liquidation of the partnership affairs.

The liability of a third person becoming a partner in the partnership continuing the business, under this article, to the creditors of the dissolved partnership shall be satisfied out of the partnership property only, unless there is a stipulation to the contrary.

When the business of a partnership after dissolution is continued under any conditions set forth in this article the creditors of the dissolved partnership, as against the separate creditors of the retiring or deceased partner or the representative of the deceased partner, have a prior right to any claim of the retired partner or the representative of the deceased partner against the person or partnership continuing the business, on account of the retired or deceased partner's interest in the dissolved partnership or on account of any consideration promised for such interest or for his right in partnership property.

Nothing in this article shall be held to modify any right of creditors to set aside any assignment on the ground of fraud.

The use by the person or partnership continuing the business of the partnership name, or the name of a deceased partner as part thereof, shall not of itself make the individual property of the deceased partner liable for any debts contracted by such person or partnership.

Dissolution of a partnership by change in membership.

Causes.

The change in the relation of the partners resulting in the dissolution of the partnership may take place:

when a new partner is admitted; or
when a partner retires or dies; or
when a partner withdraws or is expelled from the partnership; or
when the other partners assign their rights to the sole remaining partner; or
when all the partners assign their rights in partnership property to third persons.

Any change in membership dissolves a partnership and creates a new one.

Continuation of partnership without liquidation.

A partnership dissolved by any of these happenings need not undergo the procedure relating to dissolution and winding of its business affairs.
The remaining partners (and/or new partners) may elect to continue the business of the old partnership without interruption by simply:

taking over the business enterprise owned by the preceding partner and
continuing the use of the old name.

The rights and obligations of the partners as among themselves in case of such continuation are set forth in Article 1837.

As the partnership is the result of a contract, a change in the parties to the contract necessarily results in a new contract. Hence, a change in membership of a partnership creates a new partnership upon the continuation of the business by the partners.

Rights of creditors of dissolved partnership which is continued.

Article 1840 deals with the rights of creditors when the partnership is dissolved by a change of membership and its business is continued (Art. 1837[2].) by a former partner, either alone or with new partners, without liquidation of partnership affairs.

Equal rights of dissolved and new partnership creditors.

In such case, the law makes the creditors of the dissolved partnership also creditors of the persons or partnership continuing the business.

In other words, both classes of creditors, the old and the new, are treated alike, being given equal rights in partnership property.

The purpose of the law is to maintain the preferential rights of the old creditors to the partnership property as against the separate creditors of the partners.
It is immaterial to determine under which one or more of the six (6) cases mentioned in Article 1840 the dissolution falls — the creditors of the old partnership are also the creditors of the new partnership which continues the business of the old one without liquidation of the partnership affairs.
Example:

Assume that C is admitted as a new partner into the existing partnership of A and B. Technically, the old firm of A and B is dissolved and a new firm composed of A, B, and C is formed. C will not be individually liable for the debts of the old firm. His investment, however, constituting a part of the firm assets, will be equally available to both creditors of the old and creditors of the new firm. (par. 2; Art. 1826.) Various other changes in membership effect a technical dissolution, yet justice dictates that the two sets of creditors involved, those of the old and those of the new firm, be treated on an equal basis.
A note to Uniform Partnership Act provides: “Where there is a continuous business carried on first by A, B, and C, and then by A, B, C, and D, or by B and C, or by B and D, or by C and D, or by B, C, and D, without liquidation of the affairs of the dissolved partnership of A, B, and C, both justice and business convenience require that all creditors of the business, irrespective of the exact groupings of the owners at the time their respective claims had their origin, should be treated alike, all being given an equal claim on the property embarked in the business.”

Liability of persons continuing business.

Note that under paragraph 2, the liability of the new or incoming partners shall be satisfied out of partnership property only unless there is a stipulation to the contrary. (Art. 1826.)
Note that paragraph 1, No. 4, applies only when the third person continuing the business of the dissolved partnership promises to pay the debts of the partnership.

Otherwise, creditors of the dissolved partnership have no claim on the person or partnership continuing the business or its property unless the assignment can be set aside as a fraud on creditors under paragraph 4.

Example:

If A, B, and C, partners, sell the partnership business to D, and if D promises to pay the debts and to continue the business, the creditors of the dissolved partnership of A, B, and C are also the creditors of D.

Prior right of dissolved partnership creditors as against purchaser.

When a retiring or deceased partner has sold his interest in the partnership without a final settlement with creditors of the partnership, such creditors have an equitable lien on the consideration paid to the retiring or deceased partner by the purchaser thereof.
This lien comes ahead of the claims of the separate creditors of the retired or deceased partner.
Application of the rule set forth in paragraph 3 does and sometimes leave the retiring or deceased partner with a continuing liability the exact duration of which is not specified except that it shall apply only in favor of those creditors at the time of the retirement or death of a partner.

Continuation of dissolved partnership business by another company.

When corporation deemed a mere continuation of prior partnership.

The weight of authority supports the view that where a corporation was formed by, and consisted of, members of a partnership whose business and property was conveyed and transferred to the corporation for the purpose of continuing its business, in payment for which corporate capital stock was issued, such corporation is presumed to have assumed partnership debts and is prima facie liable therefor.
The reason for the rule is that the members of the partnership may be said to have simply put a new coat, or taken on a corporate cloak, and the corporation is a mere continuation of the partnership.

When obligations of company bought out considered assumed by vendee.

General Rule: In some cases, when one company buys out another and continues the business of the latter company, the buyer may be said to assume the obligations of the company bought out when said obligations are not of considerable amount or value especially when incurred in the ordinary course, and when the business of the latter is continued.
Exception: However, when said obligation is of extraordinary value, and the company was bought out not to continue its business but to stop its operation in order to eliminate competition, it cannot be said that the vendee assumed all the obligations of the rival company.

Exemption from liability of individual property of deceased partner.

Debts incurred by person or partnership continuing business.

The last paragraph of Article 1840 primarily deals with the exemption from liability to creditors of a dissolved partnership of the individual property of the deceased partner for debts contracted by the person or partnership which continues the business using the partnership name or the name of the deceased partner as part thereof. What the law contemplates is a hold-over situation preparatory to formal reorganization.

Commercial partnership continued after dissolution.

Article 1840 treats more of a commercial partnership with a goodwill to protect rather than a professional partnership (see Art. 1767, par. 2.) with no saleable goodwill but whose reputation depends on the personal qualifications of its individual members.
As a general rule, upon the dissolution of a commercial partnership, the succeeding partners or parties have the right to carry on the business under the old name, in the absence of stipulation forbidding it, since the name of a commercial partnership is a partnership asset inseparable from the goodwill of the firm.
On the other hand, a professional partnership the reputation of which depends on the individual skill of the members, such as partnerships of attorneys or physicians, has no goodwill to be distributed as a firm asset on its dissolution, however intrinsically valuable such skill and reputation may be, especially where there is no provision in the partnership agreement relating to goodwill as an asset.

Article 1841.

When any partner retires or dies,

and the business is continued under any of the conditions set forth in the preceding article,

or in article 1837, second paragraph, No. 2,

without any settlement of accounts as between him or his estate

and the person or partnership continuing the business,

unless otherwise agreed,

he or his legal representative

as against such person or partnership

may have the value of his interest at the date of dissolution ascertained,

and shall receive as an ordinary creditor an amount equal to the value of his interest in the dissolved partnership with interest,

or, at his option or at the option of his legal representative, in lieu of interest,

the profits attributable to the use of his right in the property of the dissolved partnership;

provided that the creditors of the dissolved partnership as against the separate creditors,

or the representative of the retired or deceased partner,

shall have priority on any claim arising under this article, as provided article 1840, third paragraph.

Rights of retiring, or of estate of deceased, partner when business is continued.

The business of the partnership is not always terminated after dissolution.

This is true where the business has been profitable and some of the partner’s may wish to continue the business rather than liquidate it.

When the dissolution is caused by the retirement or death of a partner and the business is continued without settlement of accounts, the retiring partner or the legal representative of the deceased partner shall have the right:

To have the value of the interest of the retiring partner or deceased partner in the partnership ascertained as of the date of dissolution (i.e., date of retirement or death); and
To receive thereafter, as an ordinary creditor, an amount equal to the value of his share in the dissolved partnership with interest, or, at his option, in lieu of interest, the profits attributable to the use of his right.

As provided in Article 1840, the creditors of a dissolved partnership have a prior right as against the separate creditors of the retired or deceased partner.

If the surviving partners (in case the dissolution is caused by the death of a partner) continue the business without the consent of the deceased partner’s estate, they do so without any risk to the estate;
If the estate consents, it, in effect, becomes a new partner and would be answerable for all debts and losses after the death but only to the extent of the decedent’s share in the partnership’s assets.

Example:

A, B, and C are partners in X & Co. which is indebted to D in the amount of P50,000.00. Later on, X & Co. was dissolved by reason of the withdrawal of C. The business was continued by A and B without any settlement of account between A and B, on the one hand, and C, on the other. C or his legal representative has the right to have the value of his interest in the partnership ascertained and paid to him. Assuming that the interest of C has been ascertained to be P30,000.00, D has priority over the claim of C, his legal representative, or his separate creditor.

Article 1842.

The right to an account of his interest

shall accrue to any partner, or his legal representative

as against the winding up partners

or the surviving partners

or the person or partnership continuing the business,

at the date of dissolution,

in the absence of any agreement to the contrary.

Accrual and prescription of a partner’s right to account of his interest.

The right to demand an accounting of the value of his interest (Art. 1812.) accrues to any partner or his legal representative after dissolution in the absence of an agreement to the contrary.
Prescription begins to run only upon the dissolution of the partnership when the final accounting is done.

Under Articles 1806, 1807, and 1809, the right to demand an accounting exists as long as the partnership exists.

Person liable to render an account.

This right of a partner or the one who represents him as owner of his interest to an account, i.e., to a statement of the partnership affairs, and, in due course of liquidation, to a payment of the amount of his interest, may be exercised as against:

The winding up partner;
The surviving partner; or
The person or partnership continuing the business.

Liquidation necessary for determination of partner’s share.

Share of the profits.

The profits of a business cannot be determined by taking into account the result of one particular transaction instead of all the transactions had.

Hence, the need for a general liquidation before a member of a partnership may claim a specific sum as his share of the profits.

When in liquidating a partnership the profits for a given period of time cannot be exactly determined for lack of evidence (e.g., the books of accounts had been destroyed by white ants [anay]), but the profits for certain periods prior and subsequent thereto are known, the profits corresponding to the said given time may be determined by finding the average of those profits already known and multiplying it by the length of time included between said periods.

Thus, assuming the liquidation of the business of a partnership for the period from 1991 to 1995 could not be made, and the net profit for the period between 1989 and 1990 is P16,000.00, the average of the profits for each of these years is P8,000.00; and assuming the net profit for the year 1996 is P11,000.00, the average between the net profit for 1989 and 1990 and the net profit for 1996 is P9,000.00, which may be considered as the average of the net annual profits for the period between 1991 and 1995, which in five years make a total of P45,000.00.

Share in the partnership.

A partner’s share cannot be returned without first dissolving and liquidating the partnership, for the firm’s outside creditors have preference over the assets of the enterprise (Arts. 1839[2], 1827.) and the firm’s property cannot be diminished to their prejudice. (see Art. 1857.)
Upon the death of a partner, the partnership assumes the status of partnership in liquidation. The only right his heirs could have would be to what might result, after such liquidation, to belong to the deceased partner, and before this is finished, it is impossible to determine what rights and interests, if any, the deceased had.
In other words, no specific amounts or properties may be adjudicated to the heir or legal representative of the deceased partner without the liquidation being first terminated.

When liquidation not required.

General Rule: When a partnership is dissolved, a partner or his legal representative is entitled to the payment of what may be due after a liquidation.
Exception: But no liquidation is necessary when there is already a settlement or an agreement as to what he shall receive.

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Partnership: Dissolution and Winding Up (Arts. 1828-1842)

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