Termination of Partnership Agreement

There are several ways to dissolve a partnership under the PA 1890. When partners all decide that the partnership should come to an end, irrespective of what is written in their partnership agreement, the PA 1890 states that they can all agree to dissolve the partnership and a dissolution agreement can be put in place. The partnership can be terminated through an end of partnership agreement.

Usually all of the partners are required to agree unless the partnership agreement states otherwise and allows that a certain majority of partners have the right to dissolve the partnership. It is better for the partners to all agree in writing that the partnership is ending but there has been case law to suggest that in some circumstances conduct. Such includes arguing between the partners, the final accounts being created or the creation of new partnerships by the partners. This may be enough for a court to conclude that a partnership has ended. If the partnership has been established for a fixed-term then the dissolution agreement can also dissolve the partnership before the end of the term. The dissolution agreement is also known as an end of partnership agreement.

In summary, if the partnership agreement does not specify the details of dissolution of the partnership, then an end of partnership agreement can be put in place and signed by all (or if allowed, a majority) of the partners. It should state that it has been agreed to terminate the partnership and set out how the division of assets and responsibilities in respect of the business and the ending of the partnership will be allocated between the partners.

Key terms can include what happens to liability for any debts of the partnership, what happens to the business name, clients and unfinished projects, how intellectual property, real estate and other assets should be divided, who prepares the final tax payments and accounts, and what happens to any records or documentation of the partnership. The partners may also want to think about how insurance arrangements and compliance with industry bodies or other regulatory authorities are dealt with following dissolution of the partnership. Therefore, the end of partnership agreement should align with the preceding.

What is considered an end of partnership agreement?

Legally a partnership continues to exist until it is terminated. What causes a partnership to end? As mentioned above, there could be numerous reasons to terminate a partnership, including personality conflicts or irreconcilable differences. However, it can also be something less dramatic, such as the partners want to change the business’s legal structure. A partnership is considered terminated if no part of its business, financial operations, or activities continues. The termination is effected through an end of partnership agreement.

In any case, the partnership agreement dictates what happens when the partnership is terminated. Without an end of partnership agreement, the termination terms are left up to the courts in your state. In the event of a partner’s death, the end of partnership agreement could require the partnership to terminate immediately and have the deceased partner’s assets be reassigned to the remaining partner(s). Or there may be a succession plan in place for the deceased partner’s family to have a stake in the business. In that scenario, the partnership is still intact because the beneficiaries are part of the business. Likewise, if one partner wants out and sells his portion to the remaining partners, the partnership still exists.

A partnership termination is necessary when the company is reduced to one owner, ceases to do business, or changes legal structure. Thus, an end of partnership agreement is required. For example, if the latter is the case:

From a partnership to a sole proprietorship: The steps to transfer ownership of the business from partners to a sole proprietorship should be documented in the end of partnership agreement. In many cases, this means one partner is buying out the others partners, and the assets and liabilities of the company will be redistributed to the remaining owner. However, without an end of partnership agreement, the assets and liabilities typically are divided equally among the original partners, who then need to create documents about each aspect of the business, including company name, customer lists, etc., and how they will be distributed.

From a partnership to a Limited Liability Company (LLC): There are several reasons a partnership may decide to restructure as an LLC. Whether there’s been a change in ownership or just a desire to change the company’s business structure, the partners need to follow the compliance rules for LLCs in their home state. This usually entails searching and filing for a legal business name, filing an LLC application with the Secretary of State, and filing an operating agreement and articles of organization. The new LLC must also obtain a Federal Tax ID number from the IRS.

From a partnership to a C Corporation: Likewise, if the partnership decides to restructure as a C Corporation, the remaining partner/s must follow the compliance rules for incorporating in their home state. This entails searching and filing for a legal business name, filing to incorporate with the Secretary of State, and creating a board of directors, creating and filing bylaws and articles of incorporation. The new corporation must also obtain a Federal Tax ID number from the IRS.

Once the partnership votes to restructure and files for the new structure, all assets and liabilities should be transferred to the new structure. This is done through the strategy set out in the end of partnership agreement. After the transfer occurs, the partners can begin the dissolution of a partnership and terminate the partnership agreement.

Difference between dissolution and termination of a partnership

In basic terms, the dissolution of a partnership refers to the steps involved in winding up the business, preparing for termination. Termination is the final result; the company has ceased all business activity and no longer exists.

How to dissolve a partnership? Generally, the steps include paying off or settling all the company’s debts, liabilities, and obligations. If all debts cannot be paid, the creditors must be notified of the dissolution so they can try and recoup some monies in court. The preceding can be done through an end of partnership agreement.

Once the partnership has started the dissolution process, the company can no longer conduct any business activity. A partner can dissolve a partnership if he or she withdraws from the partnership or if the partner dies. If the partnership is registered to do business in other states, the partners must follow that state’s rules for dissolution and termination. The end of partnership agreement should thus be drafted in accordance with the law in place.

Tax consequences of an end of partnership agreement

Any change in a business structure can result in tax consequences. Partnership termination tax consequences depend on what happens after the partnership ceases or restructures. Partnerships are considered non-tax-paying entities. The partnership itself does not pay income tax. The partners are not employees, and the partnership passes both profits and losses through to the partners.

When the partnership terminates through an end of partnership agreement, partners must pay taxes on any remaining profits and the liquidation of current and fixed assets. If the partners are not equal, per the agreement, then the distribution of remaining assets and losses will also not be equal. If the partnership restructures, then the assets and liabilities of the partnership can become part of the new entity, and the tax consequences depend on how the new company chooses to be taxed.

The importance of an end of partnership agreement

To avoid unnecessary costs and disputes between partners, it is advisable to plan in advance what happens if the partnership is considered to be no longer needed or desired by most of the partners. As a partner you do not want to be ‘trapped’ in a partnership that you do not want to be in, nor do you want to have to carry a partner that no longer wants to be involved in the business or has become detrimental to its success. Hence the need for drafting an end of partnership agreement.

A day may come where the business is no longer viable and becomes insolvent and again, it is advisable to have an exit strategy for what will happen in advance of the event occurring to make sure that the process runs smoothly. The agreement can thus be terminated through implementing an end of partnership agreement.

If you do not include a comprehensive exit clause in your partnership agreement then the terms of the PA 1890 can apply to the dissolution of your partnership. Other than a clause, partners can draft an end of partnership agreement. There are many reasons why this may not be suitable for your business, particularly if your business is well established or contains an uneven contribution of assets (as then the partners will no doubt want some control over how the partnership ends and how assets are distributed).

The PA 1890 provides a number of ways to dissolve a partnership and includes rights of dissolution on a unilateral basis. This will not always work for business partnerships that require certainty of their existence – most partnerships will not want the risk that one partner acting individually can technically dissolve the partnership, as this will have consequences for, among other things, the business, its employees, its customers and any financing that it may have.

Effective end of partnership agreement

An effective end of partnership agreement will deal with the situations where the whole partnership is to be dissolved and eventually wound up. There usually will be a separate clause or end of partnership agreement dealing with what happens when a partner leaves the partnership.

An effective end of partnership agreement should acknowledge the provisions of the PA 1890 governing the dissolution of a partnership but can also modify. Alternatively, disapply them to the extent necessary to ensure that the exit strategy of the partnership reflects what has been agreed between the business partners.

Aspects of a typical end of partnership agreement

Disapply the PA 1890 provision that a ‘partnership at will’ (this being a partnership that does not have a fixed expiry date for the duration of the business partnership) can be terminated on the notice of one of the partners. The reason for doing this is to avoid a dissolution by one partner without the agreement of the rest of the partnership. It is also meant to avoid the uncertainty of the partnership being able to be terminated without the consent of a majority or all of the partnership. If a partnership has a fixed-term then it will automatically dissolve on the expiry of that term (be it a specified date or at the end of a particular project), unless the partnership agrees otherwise and documents it in the partnership agreement. An end of partnership agreement could also state otherwise regarding the termination of the partnership.

Disapply the PA 1890 provision that a partnership can be dissolved automatically on the date that one partner dies, becomes bankrupt or if a partner allows a charge to be put over its share of the business. The dissolution will take place on a partner’s death, even if the partnership is for a fixed term that still has time to run. Again, this prevents one partner causing the partnership to end without the agreement of the other partners and most modern partnerships exclude this provision but may include it as a reason for expulsion of a partner. Hence the need

If the partnership is ending, deal with how the partnership should be wound up and assets divided up – either by bespoke provisions agreed by the partnership or by relying on the provisions of the PA 1890. If there is no bespoke provision for a particular subject deciding whether the terms of the PA 1890 should apply as a default position.

The partnership agreement might also include a provision to permit a majority of the partners to be able to force a partner to leave the partnership. This is called an ‘expulsion’ clause and could also be included in the end of partnership agreement. Reasons for expelling a partner from the partnership must generally be objective and could include breaching the partnership agreement, the expelled partner’s bankruptcy or insolvency, or their negligence, misconduct, or incapacity to act.

Alternatively, the partnership agreement could be drafted so that the partners have the option to suspend the partner instead of expelling them straight away. This has the advantage of ensuring business continuity. The same terms could also be included in the end of partnership agreement.












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