Partnership Law (Report) [2003] EWLC 283(12) (15 November 2003)

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URL: http://www.bailii.org/ew/other/EWLC/2003/283(12).html
Cite as: [2003] EWLC 283(12)

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PART XII

WINDING UP PARTNERSHIPS AND SETTLING PARTNERS' ACCOUNTS

Introduction

In this Part we discuss our proposals on the termination of a partnership. We cover the ways in which a partnership may be wound up, including our recommendations for a new method for the solvent winding up of partnerships in both jurisdictions. We discuss the circumstances in which the partnership ceases to exist and the consequences of it ceasing to exist.

We also discuss our recommendations for default rules for settling partners' accounts in a winding up. These rules are also relevant to the entitlement of an outgoing partner on withdrawal from a continuing partnership which we discussed in Part VIII above.

The termination of a partnership and its winding up

Existing law

A partnership comes to an end on the following grounds:

(1) reduction in the number of partners to below two;^[2]

(2) expiry of fixed term, subject to any agreement between the partners;^[3]

(3) termination of a single adventure or undertaking for which the partnership was entered into, subject to any agreement between the partners;^[4]

(4) notice by one partner of intention to dissolve the partnership where the partnership was entered into for an undefined time, subject to any agreement between the partners;^[5]

(5) death or bankruptcy of a partner, subject to any agreement between the partners;^[6]

(6) at the option of the other partners if any partner suffers his share of the partnership to be charged for his separate debt;^[7]

(7) occurrence of an event which makes it illegal for the partnership business to be carried on or for the partners to carry it on in partnership;^[8]

(8) dissolution by the court on one of the statutory grounds set out in section 35 of the 1890 Act; and

(9) dissolution by the unanimous agreement of the partners for the time being.

Until Hurst v Bryk

On dissolution of the partnership, section 38 of the 1890 Act comes into effect. It provides that the authority of the partners to bind the partnership and the other rights and obligations of the partners continue notwithstanding the dissolution but only so far as necessary to wind up the affairs of the partnership and to complete transactions begun but unfinished at the time of the dissolution.

Our provisional proposals

In the Joint Consultation Paper we made proposals to achieve greater stability in partnerships, to remove the right of a partner withdrawing from a partnership to insist on a winding up, and to provide an alternative to dissolution on the occurrence of most of the events listed in paragraph 12.3 above. We have discussed these issues in Part VIII of this report.

We asked consultees whether there should be special provision to deem a partnership to continue for a period after the number of partners has been reduced to one so as to enable the sole remaining partner to find a new partner. Alternatively, we asked whether the last remaining partner should be given the option of buying out the share of the last outgoing partner.

We provisionally proposed that acceptance of repudiatory breach of the partnership agreement should not terminate the contract and dissolve the partnership but that innocent partners must apply to the court for dissolution.

We proposed that section 38 of the 1890 Act should be amended to make it clear that former partners of a dissolved partnership can agree to carry on the business of the partnership with a view to the beneficial winding up of the partnership.

Consultation

Consultees were not in favour of deeming a partnership to continue to exist for a period after the number of partners has been reduced to one so as to enable the sole remaining partner to find a new partner. Several consultees thought that the suggestion was inconsistent with the essential nature of partnership which involves more than one person carrying on business. There was also only limited support for the suggestion that the last remaining partner might have the option of buying out the share of the last outgoing partner.

By contrast, there was general support for our proposal to make it clear that after dissolution

There was also general support for our proposal that a partnership with separate personality should be deemed to continue after dissolution for the purposes of winding up its affairs and completing unfinished transactions. Some consultees questioned whether the partnership should be deemed to continue, as the provision could simply provide that the partnership continued until the winding up was complete. Several consultees suggested that there should be a formal end to a partnership on completion of a winding up, for example by notice to creditors or by advertisement in the Gazette. H M Land Registry suggested that registered land could remain in the name of a partnership during winding up, but that the partnership should be obliged to transfer the title to the land before completion of the winding up. They suggested that there should be a mechanism for informing the Land Registry when a winding up was completed.

Reform recommendations

We think that it is sensible that a partnership should continue as a legal entity during the winding up, so that it can hold the assets of the partnership and discharge its liabilities during that period. We therefore recommend that the termination of the partnership should be a three-step process. The first step is where a decision is taken or an event occurs which commences the winding up of the partnership. We call that first step "the break up" of the partnership. The second step or process is the winding up of the partnership. During the winding up the partnership would continue as an entity. The third step is the termination of the partnership on completion of the winding up when the partnership would cease to exist as an entity. We call this stage "the dissolution" of the partnership.

We note that RUPA used the term "dissolution" to describe the commencement of the winding up process.

We recognise that our proposals in the Joint Consultation Paper involved the termination of the partnership on completion of the winding up without requiring any formal step or notification of that termination. Although several consultees raised the issue, we are not persuaded that there is any pressing need to advertise the completion of the winding up. If the partnership is solvent, the winding up should result in the payment of all of the creditors of the partnership before the residual proceeds of the sale of the partnership assets are distributed to the partners. If the partnership is insolvent, creditors may activate insolvency procedures and thereby supersede the partners' winding up of the partnership. Whether or not the creditors do so, the partners will retain unlimited liability for the obligations of the partnership and partnership debts can be enforced against the partners.

In order to avoid problems with overlooked assets and with liabilities which emerge or are first discovered after all the assets of a partnership have been distributed, we think that a partnership should continue to exist (a) so long as there are any assets of the partnership which have not been distributed and (b) so long as there are (or may be) any liabilities of the firm which have not been discharged or extinguished through the passage of time. This policy will prevent assets overlooked in a winding up from becoming bona vacantia and thus requiring former partners (or creditors) to establish their right to claim the property from the Crown. It will also avoid the complexity of having to transfer responsibility for extant liabilities of the firm to the partners on dissolution of the partnership. It will also simplify the rules relating to litigation and the rules of limitation and prescription.

In addition, by preserving the partnership in existence we can deal with liabilities which emerge after, and sometimes long after, a firm has ceased to trade. A classic example of a late-emerging liability is a claim against a solicitor for professional negligence by a disappointed would-be beneficiary.

Where there is only one remaining partner

We do not think that it would be appropriate to defer the break up of a partnership in which the number of partners has been reduced to one in order to enable that person to find a new partner and continue the partnership business. We agree with consultees who thought that that would not be consistent with the essence of partnership and we see no need for such a provision. If the sole remaining partner wishes to buy out the interest of the last outgoing partner he can negotiate an agreement with the latter to transfer the partnership's assets to him as a sole trader and avoid having to realise the assets of the partnership.

It would, however, be appropriate to allow a partnership to continue to exist after the number of partners has been reduced to one for the purpose of completing the winding up. It would be unnecessarily inconvenient for the partnership to terminate on the reduction of its numbers to one. It would be much simpler for the partnership to continue for the purpose of completing the winding up. This would avoid problems of the transfer of property from the name of the partnership on the event of the withdrawal of the last outgoing partner and it would prevent partnership property from becoming bona vacantia. The latter risk could eventuate where the partners overlooked the need to transfer the property before the withdrawal of the last outgoing partner or where that withdrawal was involuntary, for example through death.

As explained in paragraph 12.25 below, we recommend that where a person ceases to be a partner on the break up of a partnership, he should be treated as remaining a partner during the winding up process.

Where two or more partners remain after the break up of the partnership,

Where no partners remain

Where all partners have resigned, died or ceased to exist before the winding up is completed, we think that the partnership should continue to exist as an entity as suggested in paragraph 12.16 above. Under the existing law, the rights and obligations of partners survive the dissolution of the partnership so far as is necessary to wind up the affairs of the partnership.

We therefore recommend:

(1) That the winding up of a partnership should be a three-step process: (1) the break up of the partnership which commences the winding up, (2) the winding up and (3) the dissolution of the partnership on completion of the winding up. The partnership would continue as a legal entity until dissolution (Step 3); (Draft Bill, cls 38, 39(1) and (2) and 45)

(2) That a partnership should continue to exist as an entity (for certain limited purposes) when the number of partners is reduced to one; (Draft Bill, cl 39(1) and (2) and 43)

(3) That when a partnership breaks up it may be wound up by one or more of the partners but that where only one partner remains, his authority to bind the firm is limited to acts which are necessary to wind up the firm and complete any transactions begun but unfinished at the time of the break up; (Draft Bill, cl 43(1) and (4))

(4) That after a partnership breaks up (and there are two or more partners remaining) the partners may agree (unanimously) to carry on the partnership business with a view to the beneficial winding up of the partnership and to confer authority on a partner or partners for that purpose; there should be a default rule that other matters connected with the winding up may be decided by majority; (Draft Bill, cl 43 (2), (3), (5) and (6)) and

(5) That the third step (dissolution) should not occur until all of the partnership property and property held by the firm on trust has been distributed and all claims and liabilities of the partnership have been discharged or extinguished through the passage of time. (Draft Bill, cls 39(2) and 45)

The entitlement of partners on the break up of a partnership

In Part VIII above we pointed out that clause 38 of the draft Bill defines comprehensively the circumstances in which a partnership may break up.

We therefore recommend that on or after the break up of a partnership a person may not cease to be a partner voluntarily and that a person whose resignation notice has led to the break up of a partnership is to be treated as continuing to be a partner during the winding up of the partnership. (Draft Bill, cl 40)

A new system of winding up solvent partnerships

Existing law

Partners normally wind up partnerships on dissolution and do not require the appointment of a court officer to effect the winding up. This is in most cases the cheapest and most effective way of winding up a partnership business. Partners retain unlimited liability for the debts of the firm and are entitled to the distribution of any surplus.

On termination of a partnership any partner is entitled to apply to the court to have the partnership wound up.

In the Joint Consultation Paper we discussed the difficulties and costs involved in the procedure for winding up a partnership by means of an administration order.

In Scotland, the court on ordering the winding up of a dissolved partnership may appoint a judicial factor to wind up its affairs. We discussed in the Joint Consultation Paper the problems which arise as a result of the lack of definition of the powers of the judicial factor.

We concluded that the basic problem in both jurisdictions was the lack of an officer who could take control of the property of the partnership and exercise adequate powers to wind up the partnership in an independent way. We referred to the Harman Report which in 1960 identified the problems in English procedure and recommended that the official appointed to wind up a partnership should have all the powers of a liquidator in a compulsory winding up of a company or of a trustee in bankruptcy.

Our provisional proposals

In the Joint Consultation Paper we acknowledged that many of the problems associated with winding up partnerships could not be resolved simply by altering the system for winding up. To the extent that partnership disputes are often bitter, the affairs of dissolved partnerships tangled and partnership records incomplete, delay and expense are unavoidable. The law cannot make complicated situations simple. We suggested, however, that the law could ensure that the officers responsible for the winding up have adequate powers.

We provisionally proposed that there should be a new system for winding up solvent partnerships under court supervision in which the court could appoint a liquidator with powers and duties modelled on those of a liquidator in a members' voluntary winding up of a company. We proposed that the partnership liquidator should have express power without the sanction of the court or approval of the partners to do things necessary for the winding up of the partnership's affairs, and that he should require to obtain the prior unanimous approval of the partners to make certain compromises and to carry on the partnership business for its beneficial winding up.

We pointed out that a liquidator of a company can disclaim onerous property

We also asked consultees if partners should be able to appoint a liquidator to wind up the partnership without recourse to the court and, if so, whether a majority of partners should be able to impose a partnership liquidator on a minority. We also asked whether a partner-appointed liquidator should have the same powers and duties as those of a court-appointed liquidator.

Consultation

A clear majority of consultees in both jurisdictions supported the creation of a new system for winding up solvent partnerships.

In Scotland, there was general support for the proposed system.

There was general support for our proposals on the scheme. But the APP opposed a number of the details. They thought that giving a partner or creditor a right to apply to the court to determine any question arising in the winding up was not desirable as it could create expense and delay. They suggested that instead of empowering a partner to apply to the court for an account, the liquidator should be compelled to submit accounts annually. They also questioned the proposal that a liquidator should be under a duty to report to the court if of the opinion that the debts of the partnership could not be paid within twelve months of appointment with a view to initiating the appropriate insolvency procedure. They stated that it was frequently not possible to pay all creditors and to conclude a winding up within twelve months and suggested that instead of our proposal the liquidator should be obliged (a) to report to the court and the partners on a regular basis and (b) to report to the court upon becoming aware that the partnership is insolvent with a view to initiating the relevant insolvency procedure.

A majority of consultees supported our proposals in relation to the powers which a liquidator should be able to exercise without the sanction of the court or the approval of the partners, and those powers which may be exercised only with the partners' prior unanimous consent. Several consultees expressed reservations about the requirement of the unanimous consent of partners for compromises or arrangements with creditors. Consultees accepted the need for the partners' unanimous approval of the carrying on of the business for its beneficial winding up but some suggested that it would often be impossible to obtain that unanimity. They suggested that the liquidator should be empowered to apply to the court to obtain authority to act when there is only majority support for his proposed acts.

The APP also thought that unanimity would be impracticable. They suggested a different regime: the liquidator should submit a proposal to the partners setting out his proposed strategy and the partners should vote on the proposal. The default rule for the requisite majority for approval should be 75 per cent of the partners. The liquidator should have specific authority to determine the rights and obligations of the partners amongst themselves. An aggrieved partner or creditor should have the right to appeal to the court on the ground of unfairness in a similar manner to that available in company law where a company is under an administration order.

The Law Society of Scotland also suggested a different approach to the powers of the liquidator. They proposed that there should be three categories of powers. First, there should be those which a liquidator could exercise through his appointment which did not involve the potential for any additional liability on the partners.

A majority of English consultees supported the introduction of a power to disclaim onerous property or contracts, seeing it as assisting the orderly winding up of a partnership. Several consultees suggested that the power to disclaim should apply only to contracts entered into after the relevant legislation came into force. Some suggested that the power to disclaim should require the unanimous consent of the partners, who would be liable as a result of the termination of a contract; one consultee suggested that the power should be exercised only with leave of the court.

Several Scottish consultees questioned the need for a power to disclaim property where a partnership remained solvent and suggested that the English law of disclaimer was not compatible with Scots property law. The Law Society of Scotland suggested that the liquidator should have power to terminate contracts provided that the other contracting party could claim damages from the partnership.

Consultees were divided on the question whether the partners should have power to appoint a liquidator without recourse to the court. The majority of consultees in England and Wales who responded to the question opposed the idea as unnecessary. The APP, which supported the idea, thought that there might be cost savings and suggested that the default rule should be that partners were unanimous in their decision to appoint a liquidator. They suggested that such a liquidator should have the same powers as a court-appointed liquidator. In Scotland also consultees were divided on the question and one consultee expressed doubts as to whether an informal winding up by a liquidator would be cheaper than a winding up by a court appointee.

Reform recommendations

We think that there should be a new mechanism for winding up solvent partnerships so that, when there is deadlock between the partners on the break up of a partnership, the partnership can be wound up more speedily and cheaply than at present.

We do not propose to alter the law which allows partners as a norm to wind up the partnership by themselves. As the partners have unlimited liability for the partnership's debts, there is no need for the compulsory involvement of an independent officer, as in the winding up of limited companies.

Partners will also be able to appoint a third party, such as an accountant or lawyer, to wind up the partnership and will be able to confer powers on that person to effect a winding up on their behalf. For example, if the partners in a small partnership are unable to effect the winding up they could appoint the chartered accountant who acts for the partnership to do it for them. Through the law of agency they can confer on their appointee such powers as they possess to wind up the partnership. We see no need to empower partners to appoint a partnership liquidator when they can effect the winding up through the law of agency. Our recommendations in favour of a partnership liquidator are designed to deal with circumstances of deadlock within a partnership, where there is a need for a court-appointed official with sufficient powers to realise the assets of the partnership.

Under our proposals the courts in England and Wales will retain power to appoint a receiver or a receiver and manager in appropriate cases. Similarly in Scotland the courts will retain power to appoint a judicial factor. We expect that our recommended mechanism for a winding up by a partnership liquidator will in practice supplant receivers and managers and judicial factors.

We therefore recommend that:

(1) Partners will continue to be able to wind up the partnership themselves;

(2) Partners will continue to be able to appoint an agent to wind up the partnership on their behalf;

(3) The courts in England and Wales will continue to have power to appoint a receiver or a receiver and manager to a partnership, and in Scotland the courts will continue to have power to appoint a judicial factor; and

(4) In addition there should be a new statutory system for winding up a solvent partnership under court supervision, involving the appointment of a partnership liquidator.

Who appoints the partnership liquidator?

We think that only the court should have power to appoint a partnership liquidator. There is no need to empower partners to appoint a partnership liquidator when they can already appoint an agent to wind up the partnership. The partnership liquidator will therefore be a court officer acting under the supervision of the court. The courts which may appoint a partnership liquidator are the High Court or a county court in England and Wales, and in Scotland the Court of Session or a sheriff court.

We think that any partner or creditor of the firm should be able to apply to the court for the appointment of a partnership liquidator on or after the break up of a partnership. In addition, other persons with an interest in the winding up should be able to apply. Such persons are: (a) a person who ceased to be a partner on or after the break up of the partnership, (b) the personal representative of a deceased former partner, who but for his decease would have been entitled to take part in the winding up, and (c) the insolvency practitioner in relation to a former partner who but for his insolvency would have been entitled to take part in the winding up.

We have considered including in the draft Bill provisions specifying the limited circumstances in which a personal representative of a deceased partner or a creditor of the partnership may apply for the appointment of a partnership liquidator. On reflection, we consider this an unnecessary complication. The court will have discretion whether to appoint a partnership liquidator and can refuse to do so when it is not necessary. Thus if the partners, or some of the partners, are themselves winding up the partnership reasonably efficiently and are not failing in their duties or otherwise doing wrong, there will be no reason for the court to appoint a partnership liquidator and we would expect the court to refuse to do so. For example, we would not expect the court to appoint a liquidator on the application of a creditor (the partnership being ex hypothesi solvent) unless the creditor were able to demonstrate that the partners were unable to wind up the partnership or were failing in their duty to do so.

We therefore recommend that:

(1) Only the court should have power to appoint a partnership liquidator to a partnership which has broken up; (Draft Bill, cl 50(1))

(2) The following persons should have the right to apply to the court for the appointment of a partnership liquidator:

(a) A partner,

(b) A person who ceased to be a partner on or after the break up of the partnership,

(c) The personal representative of a deceased former partner who but for his decease would have been entitled to take part in the winding up,

(d) The insolvency practitioner in relation to a former partner who but for his insolvency would have been entitled to take part in the winding up, and

(e) A creditor of the partnership. (Draft Bill, cl 50(2) and (5))

(3) In addition, the court on ordering the break up of a partnership, on the application of a former partner (or his personal representative or insolvency practitioner) who claims that the partnership affairs are being conducted in a way that is prejudicial to his interests, should be empowered to appoint a partnership liquidator, if it considers the appointment to be necessary or expedient. (Draft Bill, cl 53(4) and Schedule 3, para 2)

The court's power to appoint a provisional liquidator

As circumstances may arise when it is necessary or expedient to appoint a partnership liquidator urgently to prevent misappropriation of partnership assets or some other wrongdoing, we think that the court should be empowered to appoint a provisional liquidator. The purpose of the appointment of a provisional liquidator would be to preserve partnership property and property which the partnership holds on trust for others pending the determination of the application to appoint a partnership liquidator. The court would have discretion to give the provisional liquidator such of the statutory powers of the partnership liquidator as it thought fit. In the order appointing the provisional liquidator, the court could state the specific statutory powers (whether powers exercisable without sanction or approval or powers exercisable only with such sanction or approval) which it conferred.

We discuss the provisional liquidator in more detail below, when discussing particular issues relating to the partnership liquidator.

We recommend that:

(1) The court should have power on an application to appoint a partnership liquidator to appoint a provisional liquidator; (Draft Bill, cl 51)

(2) The duty of the provisional liquidator should be to preserve partnership property and property held by the partnership on trust pending the determination of the application to appoint a partnership liquidator; and (Draft Bill, Schedule 5, para 2)

(3) The court should have discretion to confer on the provisional liquidator such of the statutory powers of a partnership liquidator (being the powers exercisable with or without sanction or approval) as it considers expedient for the performance of his duty. The provisional liquidator may also exercise such powers with the unanimous approval of the partners. (Draft Bill, Schedule 5, para 3)

Who may be appointed liquidator

We do not think that it is necessary that the liquidator (or provisional liquidator) should be an insolvency practitioner. The liquidator is to be appointed to carry out the winding up of a solvent partnership.

Liquidator to give security

We think that it would be appropriate in most cases that the liquidator (or provisional liquidator) should be required to find security before starting to act as liquidator (or provisional liquidator). Where an insolvency practitioner is appointed to wind up an insolvent person he must find security.

The court should be given discretion to determine whether any and what security is to be given by a liquidator (or provisional liquidator) on his appointment. In some cases, it may not be needed: for example, if the partners inform the court that it is not required. In other cases it may be advisable for the court to order security to be given, particularly where different factions of partners are in dispute as to the appropriate means of winding up. Rules of court can provide for the giving, varying and release of security.

We therefore recommend that:

(1) The liquidator should not be required to have a statutory qualification but the court should be given discretion to appoint a suitable person;

(2) The court should be given discretion to determine whether any and what security is to be given by a liquidator (or provisional liquidator) on his appointment; (Draft Bill, cls 50(3) and 51(4)) and

(3) Rules of court should provide for the appointment of the liquidator (or provisional liquidator) and the giving, varying and release of security.

The effect of the appointment of a partnership liquidator

In order to assist the efficient winding up and to minimise conflict between the partnership liquidator and the partners, it is necessary to provide that all of the powers of the partners cease on the appointment of a partnership liquidator except to the extent that the partnership liquidator agrees to their continuance. Similarly, on appointment of a provisional liquidator the powers of the partners should be suspended except so far as the provisional liquidator sanctions their continuance.

We think that there is no need to vest partnership property in the partnership liquidator on his appointment. By giving powers to the partnership liquidator and by superseding the powers of the partnership, an effective regime for winding up can be established without creating complications, including tax complications, which can arise from the automatic transfer of property. Circumstances may arise however in which the partnership liquidator might find it expedient to take title to all or part of the partnership property in order to pursue legal remedies in relation to that property in his own name.

We have also considered whether it would be appropriate to impose a statutory duty on partners to co-operate with the liquidator (or provisional liquidator). Partners owe a duty of good faith to each other and the partnership and that duty continues in the course of the winding up. It may be argued that a failure to co-operate with a liquidator (or provisional liquidator) in a solvent winding up would be a breach of that duty. Nonetheless, as a partnership liquidator (or provisional liquidator) will usually be appointed only when the partners cannot agree on the means by which to wind up the partnership informally, disputes between different partners or different factions of partners can readily be foreseen. In these circumstances we think that a statutory duty to co-operate with the liquidator (and provisional liquidator) will re-enforce the duty of good faith.

As "persons interested in the winding up"

As the appointment of a partnership liquidator is designed simply to create a more efficient and less costly regime for solvent winding up where partners are unable to agree, we think that the appointment of a partnership liquidator (or provisional liquidator) should not restrict the right of a creditor of or claimant against the partnership from pursuing or enforcing claims against the partnership. In addition a creditor of a partnership should be entitled to seek a court order to wind up the partnership on the ground of insolvency or in Scotland to sequestrate the partnership's estate, notwithstanding the appointment of a partnership liquidator (or provisional liquidator).

We therefore recommend that:

(1) All the powers of the partners cease on the appointment of the partnership liquidator, except so far as the liquidator sanctions their continuance; (Draft Bill, Schedule 4, Part 1, para 1(1))

(2) All powers of the partners should be suspended on the appointment of a provisional liquidator, except so far as the provisional liquidator sanctions their continuance; (Draft Bill, Schedule 5, para 1(1))

(3) Partnership property should not vest automatically in the partnership liquidator on his appointment;

(4) A partnership liquidator should nonetheless have a right to apply to the court to vest all or any part of the partnership property in him by his official name; (Draft Bill, Schedule 4, Part 1, para 6)

(5) The partners should be under a duty to co-operate with the partnership liquidator (or provisional liquidator) in the performance of his duties from the time of his appointment; (Draft Bill, Schedule 4, Part 1, para 1(2) and Schedule 5, para 1(2))

(6) Persons interested in the winding up (namely a person who ceased to be a partner on or after the break up, (if deceased) his personal representative or (if insolvent) an insolvency practitioner appointed in relation to him) should owe a duty of good faith towards the partnership and the partners in relation to the functions of the partnership liquidator or provisional liquidator; (Draft Bill, Schedule 4, para 1(3) and Schedule 5, para 1(3)) and

(7) The appointment of a partnership liquidator (or provisional liquidator) should not restrict the rights of creditors of, or claimants against, the partnership from pursuing and enforcing their claims against the partnership (or the partners with subsidiary liability) or from applying to wind up the partnership, or in Scotland to sequestrate the partnership's estate.

The functions of the partnership liquidator

As the partnership liquidator is a new statutory creation we think that it is appropriate that the draft Bill should include a statement of his principal duties to effect an efficient winding up of the partnership.

We recommend that the duties of the partnership liquidator should be (a) to get in and realise the partnership's assets; (b) to pay the partnership's debts and discharge its liabilities to persons other than partners (c) to distribute any remaining proceeds of realisation in accordance with the default rules or any substitute provisions in the partnership agreement and (d) to secure that all trust property is transferred to the person entitled to it or a trustee for that person. (Draft Bill, Schedule 4, Part 1, para 2)

Contracts entered into by liquidator or provisional liquidator

We think that it would be suitable in the interests of clarity to establish as a general rule that a liquidator should not be personally liable on a contract which he enters into in the performance of his functions. If a party contracting with the liquidator wishes the liquidator to incur personal liability on the contract, the contract should so provide. Where the liquidator assumes personal liability under a contract, he should be entitled to an indemnity in respect of that liability out of partnership property.

We therefore recommend that

(1) A contract entered into by a liquidator (or provisional liquidator) in the performance of his functions should be taken as entered into on behalf of the partnership, unless the contract provides that he should be personally liable on it; and

(2) If the liquidator (or provisional liquidator) assumes personal liability under the contract, he should be entitled to an indemnity out of partnership property in respect of that liability. (Draft Bill, Schedule 4, Part 1, para 5 and Schedule 5, para 4)

The powers of the partnership liquidator: (a) generally

We think that the partnership liquidator should have wide powers to realise the partnership assets and pay its debts. By conferring extensive powers on a partnership liquidator we hope to reduce the expense and delays which occur when a partnership is wound up when the partners are in deadlock.

In order to wind up a partnership efficiently, the partnership liquidator will normally require extensive powers which he can exercise without requiring the approval of the partners or the sanction of the court. It is often difficult to obtain the agreement of partners to a sensible course of action if the partnership is divided into opposing factions. It may be expensive and time-consuming to obtain the sanction of the court. We think that it is appropriate that the court should be empowered to give a partnership liquidator general powers to wind up the partnership business and that only specified powers should require the approval of the partners or the further sanction of the court.

The powers which the liquidator may exercise without approval or sanction should include power to bring or defend legal proceedings in the name of the partnership, power to sell partnership property, power to claim in a partner's or debtor's insolvency, power to borrow money on the security of the partnership's assets, power to appoint an agent, and power to execute deeds or documents in the name of the partnership. The liquidator should also be able to do all other things necessary for the winding up. This would cover all acts other than those for which specific approval or sanction should be required.

We therefore recommend that:

(1) The court should be able to give the partnership liquidator wide powers to carry out the winding up of the partnership without requiring the approval of the partners or the sanction of the court for the exercise of these powers; and

(2) The following powers should be exercisable without approval or sanction:

(a) Power to bring or defend any action or other legal proceeding in the name or on behalf of the partnership;

(b) Power to sell any partnership property by public auction or private contract;

(c) Power to do all acts and execute, in the name and on behalf of the partnership, all deeds, receipts and other documents;

(d) Power to prove, rank and claim in the bankruptcy, insolvency or sequestration of any debtor of the partnership or any partner or former partner and to receive dividends from the insolvent's estate;

(e) Power to borrow any money required on the security of the partnership's assets;

(f) Power to appoint an agent to do any business which it would be unreasonable for the liquidator to have to do himself; and

(g) Power to do all such things as may be necessary for winding up the partnership's business and affairs and distributing the proceeds of the realisation of partnership property. (Draft Bill, Schedule 4, Part 1, para 3 and Part 3)

The powers of the partnership liquidator: (b) powers requiring approval or sanction

We think that the partnership liquidator should have power to carry on the partnership business for the beneficial winding up of the partnership only with the approval of all of the partners or the sanction of the court. The partners have unlimited liability for partnership debts and they should not normally be exposed to liability from continued trading without their consent. As circumstances may occur where a partner unreasonably refuses to approve a proposal to carry on business which will demonstrably assist the beneficial winding up, the court should have power to sanction the carrying on of business, notwithstanding the lack of unanimity among the partners.

Again, because partners have unlimited liability for the debts of the partnership we think that the partnership liquidator should require approval or sanction before he (a) makes a compromise or arrangement with alleged creditors of or claimants against the partnership, and (b) compromises debts and liabilities subsisting or supposed to subsist between the partnership and other persons (including partners or former partners). While the liquidator may pay undisputed debts and obtain payment of sums which are undisputedly due to the partnership, the power to compromise is one which we think requires approval or sanction. Such approval or sanction gives a degree of protection to the partners and former partners who have secondary liability for the partnership debts. In Scotland, the power to terminate a lease, which we discuss in the succeeding paragraphs, should also require approval or sanction as the partners may be prejudiced by the partnership incurring an obligation to pay compensation or damages arising from the premature termination.

There may be circumstances in which the partners want the partnership liquidator to distribute certain items of partnership property in specie instead of realising the assets and distributing the proceeds of sale. For example a partnership agreement might envisage that particular assets would be returned to a partner on a winding up. As the partnership liquidator's primary duty is to realise the assets and to distribute the proceeds we think that there should be an express power to distribute in specie. In other cases a partner may apply in the course of a winding up to receive a particular asset instead of a sum of money equating to its value. To avoid disputes between the partners as to a partner's entitlement to such a distribution, we think that the power should require the unanimous approval of the partners or the sanction of the court unless the partnership agreement has authorised distributions in specie.

We therefore recommend that:

(1) The partnership liquidator be empowered to exercise the following powers only with the unanimous approval of the partners or the sanction of the court:

(a) Power to carry on the partnership business for the beneficial winding up of the partnership; (Draft Bill, Schedule 4, Part 1, para 3 and Part 2, para 21)

(b) Power to make a compromise or arrangement with alleged creditors or claimants against the partnership; (Draft Bill, Schedule 4, Part 1, para 3 and Part 2, para 19)

(c) Power to compromise debts and liabilities subsisting or supposed to subsist between the partnership and other persons, including partners or former partners; (Draft Bill, Schedule 4, Part 1, para 3 and Part 2, para 20)

(2) The partnership liquidator should have power to distribute partnership property in its existing form instead of realising the property and distributing the proceeds of realisation (a) if permitted to do so in the partnership agreement, (b) with the unanimous approval of the partners or (c) with the sanction of the court. (Draft Bill, Schedule 4, Part 1, para 4)

Disclaimer of onerous property or termination of long leases

We think that it would be expedient to include in a statutory regime for winding up a power to enable a partnership liquidator to terminate a long term contract which otherwise would prevent him completing the winding up of the partnership's affairs. For example, a partnership may be a tenant under a twenty-one year lease of commercial premises but have broken up when the lease has still fifteen years to run. We think that it would assist the efficient winding up of the partnership if the partnership liquidator were empowered to terminate the lease where he was unable to dispose of it within a reasonable time.

Scotland does not have a statutory regime for disclaimer of onerous property on insolvency. Nevertheless, we recommend that the partnership liquidator should have power, with approval of the partners or sanction of the court, to terminate a lease in such circumstances. The termination would not affect the right of any party (such as the landlord and any other party to the lease or any sub-tenant) to claim compensation or damages from the partnership in respect of the termination. The compensation or damages would be treated as a partnership debt and would not be enforceable against the partnership liquidator personally.

The partnership liquidator would be able to terminate the lease if after at least one year from the date of his appointment he had not disposed of the tenant's interest in the lease and he were satisfied that the partnership's interest in the lease could not be disposed of. He would require to inform the landlord of this view and give him notice terminating the lease. The notice period would vary depending on the nature of the lease. Special rules would be necessary for agricultural leases to allow the efficient hand-over of responsibility for the farm. In relation to agricultural leases in Scotland we recommend that the period of notice be either a period of between one and two years ending with the term of Whitsunday or Martinmas or such period as may be agreed between the partnership liquidator and the landlord. In relation to other leases the period should be six months or where an enactment lays down a shorter period of notice, that shorter period of notice.

In England and Wales, which have an established regime for disclaimer of property in individual and corporate insolvency, we think that the partnership liquidator should have a wide power to disclaim onerous property. As a joint sub-committee of the Insolvency Court Users Committee in co-operation with the Law Commission are reviewing the Insolvent Partnerships Order 1994 and we are not yet aware of the form which their recommendations may take, we think that it would not be appropriate to formulate a regime for disclaimer at this stage. We think that it is sufficient if the draft Bill includes a power to create subordinate legislation to provide for the disclaimer of onerous property.

We therefore recommend that:

(1) The draft Bill should include a power to make subordinate legislation to empower a partnership liquidator to disclaim onerous property (with the approval of the partners or the sanction of the court); (Draft Bill, Schedule 4, Part 1, para 7)

(2) In Scotland, a partnership liquidator should be empowered (with approval of the partners or sanction of the court) to terminate a lease of land or buildings of which the partnership is the tenant, where he has not disposed of the partnership's interest in the lease within one year after the date of his appointment and he is satisfied that a provision in the lease or a rule of law prevents the disposal of the interest. The liquidator should give the landlord a specified period of notice depending on the type of lease. In an agricultural lease the notice should be either a period of between one and two years ending in the term of Whitsun or Martinmas or such period as is agreed with the landlord. In any other lease the period should be six months or such shorter period of notice as is required by any other enactment. The termination should not affect any claim for compensation or damages in respect of the termination of the lease by any person (including a landlord or sub-tenant). The claim for damages or compensation should be a claim against the partnership and not the liquidator personally. (Draft Bill, Schedule 4, Part 1, para 8)

The partnership liquidator's accounts

It is necessary that the partnership liquidator should account to the partners and any "person interested in the winding up"

As a further protection for partners and persons interested in the winding up we think that they should have the right, where they are dissatisfied with the conduct of the partnership's affairs, to apply to the court to order an account to be taken of the partnership's affairs. The court would have discretion whether to make the order so that it could prevent vexatious applications from disrupting the efficient conduct of the winding up.

We therefore recommend that:

(1) If the winding up by the partnership liquidator continues for more than one year, he should be obliged to summon a meeting of the partners and any person interested in the winding up at the end of the first year after the date of his appointment and of each succeeding year;

(2) The partnership liquidator must lay before the meeting a full and true account of his conduct of the winding up during the preceding year; (Draft Bill, Schedule 4, Part 1, para 10)

(3) As soon as he has completed the winding up of the partnership's business, the partnership liquidator must prepare a full and true account of the winding up, summon a meeting of the partners and any person interested in the winding up and lay the account before that meeting and explain it; (Draft Bill, Schedule 4, Part 1, para 11)

(4) If the partnership liquidator fails to make up accounts or to summon a meeting, he should be guilty of an offence; (Draft Bill, Schedule 4, Part 1, paras 10(5) and 11(8)) and

(5) Any partner or person interested in the winding up who is not satisfied with the way in which the partnership liquidator is conducting the winding up may apply to the court for an order that an account be taken of the partnership's affairs. (Draft Bill, Schedule 4, Part 1, para 12)

Reference of questions to the court

During a winding up questions may arise which require to be determined by the court. We think therefore that interested parties should have the right to apply to the court to determine questions arising in the winding up of the partnership and that the court should have power to determine the questions raised and to make other appropriate orders. Issues may arise on which the partnership liquidator needs an authoritative ruling from the court. While applications to the court by partners and others to challenge a decision of the partnership liquidator may disrupt the efficient winding up of the partnership's business, we think that there must be some safety net for an aggrieved partner. The court should not be obliged to make a determination or make any order unless it considers it appropriate to do so and in determining the application can impose such terms and conditions as it thinks fit. We do not see a need for a wider power by which the court may reverse or modify any decision of the partnership liquidator.

We therefore recommend that:

(1) The partnership liquidator, a partner, a person interested in the winding up,^[71] a creditor of the partnership or a person who ceased to be a partner before the break up of the partnership may apply to the court to determine any question arising in the winding up of the partnership; and

(2) The court should have discretion whether to determine the application, to impose such terms and conditions as it thinks fit on its determination and to make any other order on the application. (Draft Bill, Schedule 4, Part 1, para 13)

The partnership liquidator and an insolvent partnership

The introduction of the partnership liquidator is designed to make the winding up of solvent partnerships more efficient where the partners are not able themselves to wind up the partnership business. It is not designed to deal with insolvency of the partnership. But in the course of winding up the partnership the partnership liquidator may discover that the partnership, which was believed to be solvent, is in fact insolvent or is likely to become insolvent. It may be possible for the partners to deal with an emerging insolvency by providing the partnership liquidator with their own funds to avert an actual insolvency. Or it may be necessary to institute insolvency procedures. In either event we think that there should be a mechanism by which the partnership liquidator reports to the court on an emerging insolvency and obtains the court's determination of the appropriate course of action. We are satisfied that our proposal that the partnership liquidator should be under a duty to report to the court if he were of the opinion that the partnership's debts could not be paid within 12 months of his appointment

On reflection, we think that it is prudent to stay with established tests of insolvency, namely the inability to pay debts and absolute (or balance sheet) insolvency.

We envisage that a partnership liquidator, on discovering that he did not, or would not, have sufficient sums to meet the firm's liabilities, would approach the partners to seek contributions to meet those liabilities. If the partners did not provide the necessary funds, the partnership liquidator would be satisfied that there was no reasonable prospect of avoiding insolvency in the winding up. At the point when the partnership liquidator was so satisfied, it would be his duty to apply to the court to commence insolvency proceedings.

In England and Wales the transition from a solvent winding up to insolvency procedure can be effected by giving the partnership liquidator power on behalf of the partnership to apply for the insolvent winding up of the partnership. The precise mechanism by which this can be achieved will depend on the outcome of the reform of the Insolvent Partnerships Order 1994, which is beyond our remit. It will also be necessary to disapply the time limit on the presentation of applications to wind up partnerships when the application is at the instance of the partnership liquidator as it is possible that his application might be made more than three years after the partnership had ceased to carry on business in England and Wales. This can be done in consequential provisions. As the time limits remain in place in the meantime, it is possible that the court might not have jurisdiction to make a winding up order against a partnership. To cover that eventuality, we think that it should be provided that where the partnership is unable to pay its debts and the partnership liquidator has reasonable grounds for believing that the court does not have jurisdiction to wind up, he should apply to the court for directions or such order as the court thinks fit.

In Scotland the same transition to insolvency procedure can be achieved by giving the partnership liquidator power to present a petition for sequestration of the firm's estate and of the estate of any insolvent partner under sections 5 and 6 of the Bankruptcy (Scotland) Act 1985.

We therefore recommend that:

(1) If a partnership is unable to pay its debts and there is no reasonable prospect of it becoming able to pay its debts, the partnership liquidator should be under a duty, within one month of the insolvency, to apply to the court for a winding up order (in England and Wales) or (in Scotland) for sequestration of the estate of the partnership; (Draft Bill, Schedule 4, para 9)

(2) If the partnership liquidator has reasonable grounds for believing that the court does not have jurisdiction to make the orders in (1) above, he should be under a duty to apply to the court for directions; (Draft Bill, Schedule 4, Part 1, para 9)

(3) If the partnership liquidator fails without reasonable excuse to comply with (1) or (2) above, he should be guilty of an offence; (Draft Bill, Schedule 4, Part 1, para 9)

(4) The partnership liquidator should have (in English law) standing to present an application to the court for the partnership to be wound up under the successor order to the Insolvent Partnerships Order 1994 and the existing time limit for presenting an application for winding up a partnership should not apply to a partnership liquidator; and

(5) The partnership liquidator should have title and interest (in Scots law) to apply to the court for sequestration of the partnership's estate and the estate of an insolvent partner under the Bankruptcy (Scotland) Act 1985. (Draft Bill, Schedule 4, Part 4)

Appointment of a replacement liquidator or removal of a liquidator

Where a partnership liquidator ceases to act and it is necessary to appoint a replacement liquidator, the court should have power to appoint a partnership liquidator. Where a partnership liquidator is guilty of misconduct or there is otherwise sufficient reason to justify his replacement as partnership liquidator, the court should have power to remove him and appoint a replacement.

We recommend that (a) if for any reason there is no partnership liquidator acting, the court should have power to appoint a partnership liquidator and (b) the court may, on cause shown, remove a partnership liquidator and appoint another. (Draft Bill, Schedule 4, Part 1, para 15)

The release and discharge of a partnership liquidator

A partnership liquidator may require to resign his office, for example as a result of ill-health. He will in any event wish to be released and obtain a discharge on completion of the winding up of the partnership. It is necessary, therefore, that the partnership liquidator is entitled to apply for release and discharge. We think that the partnership liquidator should be able to obtain release and discharge from the partnership in the first instance by summoning a meeting of the partners to consider his application. As a fall-back the partnership liquidator should be entitled to apply to the court to obtain release and discharge. He would require to give the partnership and the partners notice of such application to the court. If the partnership liquidator dies, his estate should also be entitled to release.

We have considered whether the discharge should be qualified, as in the winding up of a company, so that a liquidator could, subject to the leave of the court, be subjected to claims arising out of misfeasance or breach of fiduciary or other duty.

We therefore recommend that:

(1) A partnership liquidator should be able to resign his office by giving notice to the court, each partner, each person interested in the winding up,^[80] and (if he was appointed on an application by a creditor) the creditor; (Draft Bill, Schedule 4, Part 1, para 14)

(2) A partnership liquidator may apply for release in the first instance by summoning a meeting of the partners and any persons interested in the winding up, which failing by application to the court; (Draft Bill, Schedule 4, Part 1, para 16) and

(3) The release should have effect to discharge the partnership liquidator of all liability to the partnership, the partners, former partners and the estates of former partners in respect of any act or omission in the exercise of his functions and otherwise in relation to his conduct as liquidator (unless the liquidator has obtained his release by fraud or deliberate concealment of wrongdoing). (Draft Bill, Schedule 4, Part 1, para 16)

The expenses of winding up

The partnership liquidator (or provisional liquidator) should be entitled to use the partnership's assets to fund the proper carrying on of the winding up and to receive his remuneration out of those assets.

We therefore recommend that all expenses properly incurred in the winding up, including the remuneration of the partnership liquidator and any provisional liquidator should be payable out of the partnership's assets in priority to all other claims. (Draft Bill, Schedule 4, Part 1, para 17)

The resignation, removal and release of a provisional liquidator

We have discussed above the power of the court to appoint a provisional liquidator,

It is necessary also to provide for the termination of the appointment of the provisional liquidator. We think that it is appropriate that he should be able to resign in the same way as a partnership liquidator. He should also cease to hold office on the determination of the application to the court for the appointment of a partnership liquidator. We think that the court should be able to appoint a replacement provisional liquidator if there is no-one acting and where necessary to remove a provisional liquidator and appoint another. In addition the provisional liquidator should be entitled to release if the court grants an application for release.

We therefore recommend that:

(1) A provisional liquidator should be able to resign his office by giving notice to the court, each partner, each person interested in the winding up, and (if he was appointed on an application by a creditor) the creditor; (Draft Bill, Schedule 5, para 5)

(2) A provisional liquidator should cease to hold office on the determination of the application to the court to appoint a partnership liquidator; (Draft Bill, Schedule 5, para 7)

(3) If for any reason there is no provisional liquidator acting, the court may appoint a provisional liquidator and the court may, on cause shown, remove a provisional liquidator and appoint another; (Draft Bill, Schedule 5, para 6)

(4) A provisional liquidator (or if he has died his personal representative) should be able to apply for release to the court and the court may order his release from the time specified in the order; (Draft Bill, Schedule 5, para 8(1) and (2))

(5) On release a provisional liquidator should be discharged from all liability to the partnership, partners, former partners and the estates of former partners in respect of any act or omission in the exercise of his functions and otherwise in relation to his conduct as provisional liquidator (unless the liquidator has obtained his release by fraud or deliberate concealment of wrongdoing).^[87] (Draft Bill, Schedule 5, para 8(3))

Rule-making power

We recognise that there are matters relating to the solvent winding up of partnerships which are better dealt with in subordinate legislation than in the draft Bill. In particular we consider that the remuneration of the partnership liquidator and the provisional liquidator is a matter which is appropriate for such rules. We consider that there should therefore be a rule-making power for the purpose of giving effect to the solvent winding up of partnerships.

We recommend that the Secretary of State should be empowered to make rules for the purpose of giving effect to the provisions of the draft Bill in relation to the solvent winding up of partnerships and in particular to provide for the remuneration of the partnership liquidator and the provisional liquidator. (Draft Bill, Schedule 4, Part 1, para 18 and Schedule 5 para 9)

The liability and common law duties of a partnership liquidator or provisional liquidator

We have discussed above the recommendations that as a general rule a partnership liquidator or a provisional liquidator should not incur personal liability on contracts which he enters into in the performance of his functions.

A partnership liquidator or a provisional liquidator would owe duties of care in tort and, in Scotland, delict in such circumstances as those duties arise in the common law. Thus the liquidator would owe a duty of care to persons whom he could reasonably foresee were likely to suffer personal injury or physical damage to their property as a result of his acts and omissions, in accordance with the general law. Similarly, and again in accordance with the general law, he would owe a duty to take reasonable care to avoid causing economic loss where he had assumed personal responsibility for the economic interests of a person and he knew that that person was relying on his professional expertise.

Settling partners' accounts

Existing law

Section 44 of the 1890 Act sets out the default rules which govern the substantive rights of partners on a dissolution of the partnership. Section 44

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

(a) Losses, including losses and deficiencies of capital, shall be paid first out of profits, next out of capital and lastly, if necessary, by the partners individually in the proportion in which they were entitled to share profits:

(b) The assets of the firm including the sums, if any, contributed by the partners to make up losses or deficiencies of capital, shall be applied in the following manner and order:

1. In paying the debts and liabilities of the firm to persons who are not partners therein:

2. In paying to each partner rateably what is due from the firm to him for advances as distinguished from capital:

3. In paying to each partner rateably what is due from the firm to him in respect of capital:

4. The ultimate residue, if any, shall be divided among the partners in the proportion in which profits are divisible.

It is useful to give an example of the operation of the section.

The payment of outside creditors and Y's advance leaves surplus assets of £6,000. There has thus been an overall loss of £12,000 capital (the difference between the surplus assets and the partnership's capital). This must be made up by the partners in the same proportion in which they share profits.

Profits are divisible equally, so X, Y and Z must each contribute £4,000. In the final settlement of their accounts, X receives £5,000 (£9,000 capital less £4,000 contribution to loss), Y receives £4,000 (£6,000 capital plus £2,000 advance less £4,000 contribution to loss), and Z has to contribute £1,000 (the difference between the £4,000 contribution to loss and the £3,000 capital due to him).

This is straightforward. The process is more complicated where there is a trading loss and one of the partners is insolvent. In Garner v Murray

Garner v Murray

Taking the example in paragraphs 12.110 and 12.111, with Z insolvent, the surplus assets of the partnership (£6,000) would be enhanced by the notional contributions of X and Y (£4,000 each) towards the deficiency of capital. This results in total assets available for distribution after the payment of debts and advances of £14,000. This is divided between X and Y in the ratio 3:2, reflecting their capital entitlements. X receives £4,400 (£8,400 less £4,000 contribution) and Y receives £3,600 (£5,600 plus the advance of £2,000 less £4,000 contribution).

The "rule" in Garner v Murray does not cover the circumstance where the partnership's assets are insufficient to meet the claims of outside creditors.

Our provisional proposals

In the Joint Consultation Paper we did not propose any substantive changes to the rules for distribution of assets on final settlement of accounts. We asked consultees whether section 44 of the 1890 Act operates in a satisfactory way and in particular where the "rule" in Garner v Murray applies.

Consultation

The overwhelming response of the consultees who addressed the issue was that the current rules are satisfactory. Our consultant, Roderick Banks, has suggested that there might be merit in a statutory statement of the "rule" in Garner v Murray. The Institute of Chartered Accountants in England and Wales, on the other hand, suggested that the "rule" was well understood. However concerns were expressed about the position of the partner who leaves in his current account undrawn profits in order to provide liquidity to the partnership.

Taking the example in paragraphs 12.110 and 12.111 above, suppose that in addition to the advance of £2,000, Y left in his current account undrawn profits of £6,000. The payment of outside creditors (£2,000) and Y's advance (£2,000) would reduce assets of the partnership to £6,000. There would be an overall loss of £12,000 capital which would be paid first out of Y's profits (£6,000) and the balance made good by the partners equally (£2,000 each) in accordance with their equal profit shares, all in terms of s 44(a) of the 1890 Act. This, it was suggested to us, is a trap for the unwary.

Reform recommendations

We think that it would be appropriate to reformulate the default rules for the distribution of assets on the final settlement of accounts. First, we have recommended the abolition of the default rule that partners should share equally in the capital of the firm.

We have also considered the circumstance, which is not infrequent in a failed partnership, where one or more of the partners has taken out of the firm more than his profit share and is thus in deficit in his current account. He will be a debtor of the partnership to that extent and should be required to repay his debt in the context of the settlement of accounts between the partners.

We think that the following would be appropriate default rules for the settlement of accounts.

First, partners

(1) in paying the debts of the firm to persons who are not partners;

(2) in paying to each partner rateably what is due from the firm to him for advances and undrawn profits;

(3) in paying to each partner rateably what is due from the firm to him in respect of capital; and

(4) in dividing the ultimate residue, if any, among the partners in the proportion in which profits are divisible.

Thirdly, in the event that there is a deficiency of assets to meet the claims of third party creditors and the entitlement of partners to payment of advances and undrawn profits, the partners will be liable to contribute to the partnership towards that deficiency in the proportion in which they share losses.

This code would treat partners who had overdrawn their current account as debtors of the firm and partners who had made advances to the firm or had retained part of their profit share in the firm as its creditors.

Garner v Murray

In the event that a partner was not able to make his contribution to the deficiency of assets, the other partners would have to contribute in the proportion in which those partners share partnership losses.

Under this default regime a partner is obliged to contribute to a deficiency of assets to meet the firm's obligations to third party creditors of the firm and to partners (other than for repayment of capital contributions) only if he is secondarily liable for the obligations in question. Partners may have secondary liability to a third party creditor, for example because they were partners when the firm entered into the contract which gave rise to that liability. In addition, a continuing partnership may have given a former partner an indemnity when he resigned and some of the partners in the partnership may not have secondary liability to third party creditors in relation to whose claims the indemnity was given but may potentially be secondarily liable to the former partner under that indemnity. If a partner is personally liable for an obligation to the third party or would be personally liable under the indemnity to the former partner, he is liable to contribute to the deficiency of assets. By this means the norm in a partnership which has continued on changes in membership will be that the persons who are partners at the break up of the partnership will have liability to contribute to any shortfall to third parties and to their co-partners (except in respect of capital).

We emphasise that these rules are default rules. Where the partners have agreed a different set of rules in relation to partners' contributions in a winding up, those different rules will apply.

We therefore recommend that the following should be the default rules on settlement of partners' accounts in a winding up:

(1) First, partners are to pay any sums which they are due to the partnership.

(2) Secondly, the assets of the partnership, including the sums repaid by partners in (1) above, are to be distributed in the following manner and order:

(a) In paying the debts of the partnership to persons who are not partners;

(b) In paying to each partner what is due from the partnership to him (other than in respect of capital);

(c) In paying to each partner rateably what is due from the partnership to him in respect of capital; and

(d) In dividing the ultimate residue, if any, among the partners in the proportion in which profits are divisible.

(3) If the partnership has insufficient assets to pay sums due to third party creditors and to repay to partners the sums due to them (other than in respect of capital), the partners individually shall contribute to the partnership towards that deficiency in the proportions in which they were liable to share partnership losses;^[102]

(4) The partners who are liable to contribute under (3) above are those who are personally liable for the partnership obligations or who would be personally liable for an indemnity granted by the partnership to a former partner in respect of those obligations;

(5) If a partner is not liable or, as a result of insolvency, is not able to make his contribution to the deficiency in (3) above, the other partners shall contribute the additional amount needed to meet the deficiency in the proportions in which those partners are liable (as between themselves) to contribute to that deficiency; and

(6) In this context a "partner" includes a person who ceased to be a partner on or after the break up. (Draft Bill, cl 44)

Ý
Ü Þ

Note 1    This is because the default valuation of the outgoing partner’s share is based on a hypothetical sale of either the assets of the partnership or the partnership business as a going concern and the winding up of the partnership immediately thereafter. See para 8.75 above.    [Back]

Note 2    This results from the essence of partnership before the 1890 Act as a relationship or association of persons and also the definition of partnership in 1890 Act, s 1.    [Back]

Note 3    1890 Act, s 32(a).    [Back]

Note 4    1890 Act, s 32(b).    [Back]

Note 5    1890 Act, s 26.    [Back]

Note 6    1890 Act, s 33(1).    [Back]

Note 7    1890 Act, s 33(2).    [Back]

Note 8    1890 Act, s 34.    [Back]

Note 9    [2002] 1 AC 185.    [Back]

Note 10    Joint Consultation Paper, para 6.64.    [Back]

Note 11    Joint Consultation Paper, para 6.32.    [Back]

Note 12    Joint Consultation Paper, para 6.35.    [Back]

Note 13    Joint Consultation Paper, para 6.48.    [Back]

Note 14    See paras 8.119 – 8.136 above.    [Back]

Note 15    Joint Consultation Paper, para 8.17.    [Back]

Note 16    Joint Consultation Paper, para 8.28.    [Back]

Note 17    “Dissolution” is the term used in the present law to signify the termination of the partnership and the commencement of the winding up. Under our recommendations it will signify the termination of the partnership (the dissolution of the entity) once all assets have been distributed and all liabilities discharged or extinguished through the passage of time. See para 12.23 below.    [Back]

Note 18    RUPA, s 801.    [Back]

Note 19    See Donald J Weidner, “Pitfalls in Partnership Law Reform: some United States Experience” [2001] Vol 26 Journal of Corporation Law, 1031.    [Back]

Note 20    It would be consistent with the use of the term in company law. See eg Insolvency Act 1986, ss 201 – 205.    [Back]

Note 21    It has been suggested to us that there could be a problem if a claim against a partnership proved to be unfounded and was dismissed. We do not think so. The pursuit of the claim would be sufficient to keep the partnership in being. In addition, the partnership would incur liabilities for example to its solicitors in defending the claim and when successful in the litigation would have an asset to distribute in the form of a right to costs (expenses) against the unsuccessful claimant.    [Back]

Note 22    See eg White v Jones [1995] 2 AC 207.    [Back]

Note 23    Under existing English law, and Scots law also, the mutual rights and duties of partners survive the dissolution of a partnership and could be relevant many years after a partnership had ceased to exist if a liability were to emerge or an overlooked asset were discovered and proved to be valuable.    [Back]

Note 24    Once a partnership breaks up (on whatever ground), the subsequent dissolution of the partnership is inevitable. Thus where the ground of break up is the reduction of the number of partners to one, the partnership must be wound up. We suggest below (para 12.21) that where there are two or more partners after break-up, they can agree to carry on the partnership business to achieve a beneficial winding up. We do not allow a sole remaining partner to carry on the business as a partner in the winding up as there is no other partner and it appears artificial to treat the sole partner other than as a sole trader – see para 12.20 below.     [Back]

Note 25    See draft Bill, cl 40.    [Back]

Note 26    This would occur where he is the only partner at the time of the break up who has not died or been dissolved, become insolvent, been expelled or been removed by court order.    [Back]

Note 27    See draft Bill, cl 1 and Sched 1.    [Back]

Note 28    This includes the circumstance where a partner whose resignation has caused the break up of the partnership is treated under cl 40 of the draft Bill as a continuing partner during the winding up. See para 12.25 below.    [Back]

Note 29    1890 Act, s 38.    [Back]

Note 30    See para 8.30 above.    [Back]

Note 31    See para 8.100 above.    [Back]

Note 32    And also any partners who gave notice of resignation in response to the first partner’s notice.    [Back]

Note 33    But he may cease to be a partner involuntarily, through, for example, death or bankruptcy.     [Back]

Note 34    1890 Act, s 39.    [Back]

Note 35    Joint Consultation Paper, paras 8.33 - 8.36.    [Back]

Note 36    Joint Consultation Paper, paras 8.37 - 8.40.    [Back]

Note 37    Report of the Committee on Chancery Chambers and the Chancery Registrar’s Office, 1960, Cmnd 967, para 95(2). See Joint Consultation Paper, paras 8.41 – 8.43.    [Back]

Note 38    Report of the Review Body on the Chancery Division of the High Court (1981) Cmnd 8205 p 46, para 146(vi).    [Back]

Note 39    Joint Consultation Paper, paras 8.44 – 8.52, 8.60.    [Back]

Note 40    Joint Consultation Paper, paras 8.53 and 8.60.    [Back]

Note 41    Joint Consultation Paper, paras 8.46 and 8.60.    [Back]

Note 42    Insolvency Act 1986, ss 178 – 182 apply only to England and Wales. In Scotland the rules in relation to disclaimer of contracts by company liquidators are a matter of the common law. See Joint Consultation Paper, para 8.54.    [Back]

Note 43    Joint Consultation Paper, paras 8.54 – 8.58, 8.60.    [Back]

Note 44    Joint Consultation Paper, paras 8.64 – 8.66.    [Back]

Note 45    The Institute of Chartered Accountants in England and Wales suggested that the proposals were very welcome. NILRAC emphasised the need to replace the present system which they suggested was entirely unsatisfactory and unduly complex. Peter Gibson LJ welcomed the implementation of the recommendation of the Harman Committee (see para 12.30 above) which he considered long overdue.    [Back]

Note 46    Our proposal envisaged that it would be open to partners to wind up the partnership themselves and that the new system would be available when disputes between the partners or other circumstances made it impracticable for the partners to do so.    [Back]

Note 47    The Newcastle Upon Tyne Law Society also suggested that the proposed system would be as expensive and slow as the present system. Osborne Clark OWA thought that the proposed reforms were unnecessary. Elspeth Deards suggested that it would be sufficient to extend the powers of receivers and managers to manage the business and that the court should remain the final arbiter of the rights of the partners amongst themselves.    [Back]

Note 48    The Faculty of Advocates, the Law Society of Scotland, the Royal Faculty of Procurators in Glasgow and the Scottish Chamber of Commerce among others supported the proposal. The Scottish Law Commission’s Advisory Group, which includes practitioners with expertise in winding up partnerships, also supported the proposed system.    [Back]

Note 49    Professor Gretton argued that the use of the judicial factor would be preferable as a liquidator would be a novelty in Scots law and that this would encourage litigation. The Scottish Law Commission considered the option of developing the office of judicial factor when preparing the Joint Consultation Paper. It carried out a research exercise on the use of judicial factors in partnerships and concluded that it was not practicable to reform the law of judicial factors in relationship to partnerships except in the context of a general reform of the law of judicial factors.    [Back]

Note 50    Again the consultee may have misunderstood our proposal. See footnote 46 above.    [Back]

Note 51    Insolvency Act 1986, s 27.    [Back]

Note 52    They suggested that these should be payments to or compromises with creditors, sale of partnership property, execution of documents, ranking in bankruptcy, drawing cheques, the appointment of an agent and any other act which is necessary for the winding up for which sanction is not specifically required.    [Back]

Note 53    They suggested that the following powers should require the sanction of a 75% majority of partners: compromises with a partner or former partner and borrowing on the security of the partnership’s assets (up to a specified proportion of the value of the assets).    [Back]

Note 54    They proposed that these powers should be (a) the bringing or defending of legal proceedings, (b) any borrowing in excess of a specified limit and (c) carrying on the partnership business.    [Back]

Note 55    Professor Morse.    [Back]

Note 56    See the definition of “the court” in the draft Bill, cl 76(1).    [Back]

Note 57    See draft Bill, cl 50(2) and (5).    [Back]

Note 58    See draft Bill, cl 53 and Sched 3, para 2.    [Back]

Note 59    We recommend below that the liquidator should apply to the court to initiate insolvency proceedings where he is satisfied that insolvency cannot be avoided. See paras 12.89 – 12.94 below.    [Back]

Note 60    See the Insolvency Act 1986, s 390(3) and the Insolvency Practitioners Regulations 1990 (SI 1990 No 439), Regulation 12 (as amended by the Insolvency Practitioners (Amendment) Regulations 1993 (SI 1993 No 221), Regulation 5) and Sched 2.     [Back]

Note 61    From 1890 to 1985 a court appointed liquidator was required to give security. See the Companies (Winding Up) Act 1890, s 4(3) and the Companies Act 1948, ss 240(a) and 241(a).     [Back]

Note 62    See Palmer, Palmer’s Company Law (23rd ed 1982) para 86.52.    [Back]

Note 63    In English law this would include property in which the partnership had the beneficial interest, such as property held in trust by another person for the partnership. In Scots law the ius crediti of the partnership as beneficiary of a trust would vest, enabling the liquidator to call on a bare trustee to transfer the asset to him: an application for a vesting order could be combined with an application to order the trustee to denude.    [Back]

Note 64    There is a precedent in relation to liquidators who are winding up companies in the Insolvency Act 1986, s 145.    [Back]

Note 65    A “person interested in the winding up” is defined in the draft Bill, cl 50(5). See paras 12.51 and 12.53(2) above.    [Back]

Note 66    For example, the partners might agree in a partnership agreement that an asset would be transferred to a partner on a winding up at a specified value which might be less than market value. The partnership liquidator should have power to give effect to such an agreement and would in normal circumstances have no reason not to do so. But we do not recommend that a partnership liquidator should be obliged to carry out the partners’ wishes (whether in the partnership agreement or in the course of the winding up) because there may be circumstances where the threat of an emerging insolvency would make a transfer at an undervalue inappropriate.    [Back]

Note 67    We generally do not favour the use of subordinate legislation in relation to the draft Partnerships Bill as we wish the basic rules of partnership to be accessible in a statute. However a partnership liquidator will be professionally qualified and should have ready access to subordinate legislation.     [Back]

Note 68    See para 12.51 above and draft Bill cl 50(5) for the definition of a “person interested in the winding up”.    [Back]

Note 69    See the draft Bill, Sched 4, Part 1, para 11(6).    [Back]

Note 70    cf Insolvency Act 1986, s 263(3) (court control of a supervisor of a voluntary arrangement). We do not think that it is appropriate to give partners and others a right of appeal from the decisions of the liquidator: a dissident partner could use such a right to delay the winding up. The partnership liquidator is intended to have greater independence of the parties and the court than the receiver and manager or, in Scotland, the judicial factor. A right of appeal to the court against a liquidator’s decisions could undermine this policy.     [Back]

Note 71    See para 12.51 above and draft Bill, cl 50(5) for the definition of a “person interested in the winding up”.    [Back]

Note 72    Joint Consultation Paper, para 8.46.    [Back]

Note 73    See the Insolvency Act 1986, s 122(1)(f) and 122(1)(e) & (2).    [Back]

Note 74    In England and Wales the proceedings would be under the replacement of the Insolvent Partnerships Order 1994; in Scotland the application would be under the Bankruptcy (Scotland) Act 1985.    [Back]

Note 75    The removal should be on cause shown: by analogy with company law we suggest that cause might include failure to carry out duties in a diligent and proper manner, misconduct, conflicts of interest and persistently acting against the wishes of a majority of the partners who are acting in good faith – viz Gore-Browne, Gore-Browne on Companies (44th ed 1996) paras 32.18.2 and 32.18.5 and Palmer, Palmer’s Company Law (25th ed 1992) paras 15.154 – 15.154.2 and 15.644.     [Back]

Note 76    See the Insolvency Act 1986, s 212. In relation to personal bankruptcy, similar rules exist in English law (Insolvency Act 1986, s 304) while in Scotland the discharge of a trustee in sequestration releases the permanent trustee from all liability except liability arising from fraud (Bankruptcy (Scotland) Act 1985, s 57(5)).     [Back]

Note 77    This is because we provide in the draft Bill, Sched 4, para 16(1), that the liquidator is released at the final meeting only if he has complied with para 11 of that Schedule, which requires him to have an honest belief that he has performed his duties as liquidator and to make up an account on that basis.    [Back]

Note 78    This could be achieved in an appeal from the court’s order, where that was competent, or in a separate action on the ground of the liquidator’s dishonesty or fraud. See, for example, Kuwait Airways Corporation v Iraqi Airways Co (No 2) [2001] 1 WLR 429.    [Back]

Note 79    This is because the release would discharge the liquidator in respect of his acts or omissions in the winding up and in relation to his conduct as liquidator. It would not authorise him to retain another’s property after he had ceased to be liquidator.     [Back]

Note 80    See para 12.51 above and the draft Bill, cl 50(5) for definition of a “person interested in the winding up”.    [Back]

Note 81    We envisage that the cost of any security which he gives on the order of the court together with the cost of any applications to vary the amount of or discharge the security would normally be treated as expenses properly incurred.    [Back]

Note 82    See paras 12.54 – 12.56 above.    [Back]

Note 83    See paras 12.58 – 12.60 above.    [Back]

Note 84    See paras 12.54 – 12.56 above.    [Back]

Note 85    See paras 12.69 – 12.70 above.    [Back]

Note 86    See para 12.66(5) and (6) above.    [Back]

Note 87    See para 12.98 above.    [Back]

Note 88    We consider that the power to make rules in Scotland in relation to the solvent winding up of partnerships is a reserved matter and is therefore within the jurisdiction of the Secretary of State: see Scotland Act 1998, s 30 and Sched 5, Head C, ss C 1 and C 2.    [Back]

Note 89    See paras 12.69 – 12.70 above.    [Back]

Note 90    See Henderson v Merrett Syndicates Ltd [1995] 2 AC 145, Bank of Scotland v Fuller Peiser 2002 SLT 574.    [Back]

Note 91    The 1890 Act, s 44 follows almost word for word Lord Lindley’s suggestion of an appropriate default rule for settling accounts in the 5th edition of Lindley on Partnership (1888) p 402. Interestingly, s 44(a) includes “losses and deficiencies of capital”, to which Lord Lindley did not refer, and provides for payment first out of “profits” while Lord Lindley referred to “assets excluding capital”.    [Back]

Note 92    We gave this example in the Joint Consultation Paper, paras 8.68 – 8.70.    [Back]

Note 93    [1904] 1 Ch 57, 60.     [Back]

Note 94    See Lindley & Banks, para 25-52.     [Back]

Note 95    See Higgins & Fletcher, The Law of Partnership in Australia and New Zealand, op cit, at p 263.    [Back]

Note 96    By reference to their shares of the profits under the default rule in the 1890 Act, s 44(b)(4).    [Back]

Note 97    The trap is avoided if one treats undrawn profits as an advance to the partnership for the purposes of s 44(a). But it is not clear that undrawn profits are properly treated as a loan.    [Back]

Note 98    See para 10.30 above.    [Back]

Note 99    The recommendation to remove the default entitlement to equal shares of capital itself undermines the principle of community of profits and losses. We think that the removal of this equal entitlement is balanced by the removal of the obligation to contribute to deficiencies of capital.    [Back]

Note 100    In this context a partner includes a person who ceased to be a partner on or after the break up of the partnership or the estate of such a person.    [Back]

Note 101    This would be consistent with an entity approach to partnership. The partners would also be creditors of the partnership in relation to their capital, but under our recommended scheme, a partner’s capital would not be protected by any obligation of the other partners to contribute to deficiencies.    [Back]

Note 102    For the default rule of equality of contribution to losses see draft Bill, cl 11(2).    [Back]

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