What is a Partnership Dissolution Agreement?
A partnership dissolution agreement is a legally binding document that delineates how to dissolve the partnership. It provides a step-by-step roadmap for the dissolution process, helping to ensure that all parties complete the process correctly, without encountering any major disputes or roadblocks. It is important to create the correct partnership dissolution agreement if you are moving forward with the dissolution process.
More generally , a partnership dissolution agreement gives each member the security needed to move forward with the dissolution of a partnership. It outsources the responsibility of the dissolution process by delegating tasks to members, laying out terms of the process, and forcing members to make certain decisions. The dissolution agreement informs all members of the necessary steps for completing the dissolution process. It is therefore one of the most essential steps in the partnership dissolution process.
Key Elements of a Partnership Dissolution Agreement
The key components of a partnership dissolution agreement can vary depending on the specific circumstances of the partnership. However, there are a number of common elements that are typically included in such an agreement. A partnership dissolution agreement should outline the terms and provisions governing the order and manner of the disposition of the assets of the partnership. The agreement should also discuss the final distribution of profits and losses to the various partners. A partnership dissolution agreement will also typically include obligations and liabilities related to the dissolution. Following the forming of the partnership agreement, the terms of a dissolution can and should be determined and set forth in writing so as accomplish the goal of a smooth and comprehensive dissolution.
A typical partnership dissolution agreement will require the exchange of assets. The distribution of assets will first take place by payment or satisfactory provision for the priority rights of creditors, then the payment of loans advanced by the partnership into the partnership and lastly the distribution among partners in proportion to the interest that the partner held in the partnership assets prior to the dissolution.
Assuming the partnership has sufficient resources, liabilities should be settled in good faith by the payment of debts and obligations of the partnership. If the partnership does not have enough assets to settle its obligations, the remaining assets of the partnership are distributed to the partners likewise to their share of distribution of assets.
While some relationships will naturally end on amicable terms, there are still those who dissolve their business or partnership while embroiled in a dispute concerning the management or conduct of the business. In those situations, the dissolution agreement’s provisions concerning liabilities can be used in a way that is advantageous and fair to all partners but simultaneously head off any sort of intentional mismanagement, misconduct or other illicit activity from occurring.
How to Create a Partnership Dissolution Agreement
When deciding to dissolve the partnership, before drafting the partnership dissolution agreement, some initial things to consider are:
- The effect of termination of remaining contracts with clients, vendors, landlords, and any other agreements in play.
- Any state law that might affect the dissolution process.
- Any restrictions on the ability to practice post-partnership.
- How decisions such as where to house offices, whether to hire or terminate employees, and other decisions will be made.
- The financial windfall or benefit, if any, that will flow to the departing partner.
- Whether any transfer of ownership in the partnership and its assets should be equal. Many times, if one partner is leaving the partnership and will no longer work for the organization, they may be entitled to a larger share of the partnership value than an even split would represent.
The most important thing to be sure of when dissolving a partnership is that the partners themselves understand the terms of the agreement and that it is in their best interest to sign it. Be careful to watch your words and not use legal jargon that you may be used to. And make sure to give the agreement enough time to be reviewed before having the partners sign. If the agreement is rushed, it may cause some animosity and dissatisfaction with the terms of the agreement, and can lead to issues later on in the dissolution of the partnership.
It is very important that all terms of the partnership be negotiated before creating the agreement. Since this is a sensitive issue, one can expect that the negotiation will be heated at times. Keep the conversation focused on the facts of the case and off of personal feelings and other extraneous issues. Keep an open mind, however, because a complaint should be heard with an ear to finding a compromise that will satisfy both parties. Treat the other partner or partners, as well as the issue being resolved, with respect.
Make arrangements for a third-party witness to verify the signing of the agreement, preferably someone familiar with the terms of the agreement who is not a party to it. Have this witness sign after both parties have.
Legal Aspects of Dissolving a Partnership
Once a partnership has decided it no longer wishes to continue, it needs to take the proper legal steps needed to dissolve. According to IRS Publication 541 (which states that "The information in this publication will help you understand some of the tax issues you face in either setting up or taking apart a partnership"), in order to dissolve a partnership, a partnership must be terminated according to state law and also requires compliance with any applicable state publication. A plan must be established that allows you to follow the dissolution and wind-up period that is longer than 12 months and determines the dividing of assets and liabilities among the partners.
If the partnership has more assets than liabilities, the remaining assets of the partnership are to be divided in accordance with the hereinafter descriptions. Before accruing the partnership liabilities, any remaining liabilities of the partnership must be paid. The remaining assets are to be divided in accordance with their respective shares of the liquidating distributions to partners. A liquidation of the assets occurs along with the distribution of cash and other assets. If the partnership has more liabilities than assets, all the remaining assets then pass to the creditors. If any obligations are not performed, general partners are to be liable for the act of debt for the purpose of the partnership liability.
Partnership Dissolution Agreement Template
A partnership dissolution agreement template generally contains a similar structure and certain key clauses. The following information provides an overview guideline of clauses which may be contained within a partnership dissolution agreement:
Purpose and Background
The purpose of a partnership dissolution agreement is to summarize the intent of the parties to dissolve the partnership and to outline the objectives and tasks to be completed in order to effectuate the dissolution.
Termination Clause
A termination clause will typically provide that the dissolution shall be effective as of___________ (insert date) (the "Effective Date").
Disposition of Partnership Property
This clause will set forth terms related to the distribution of all property owned by the partnership. This may be referred to as the "disposition and distribution of assets" clause, or something similar. For example, the clause may state that all property is to be distributed (as provided in Schedule A) according to the ownership interests for each party, after all liabilities are paid.
Payment of Debts
The agreement should set forth that all debts and obligations are to be paid from partnership assets and to provide a payment schedule , if applicable. All partnership liabilities should be satisfied prior to the distribution of any property to the partners. Language commonly used in these types of agreements includes, for example:
"PRIOR TO THE DISTRIBUTION OF ANY PARTNERSHIP PROPERTY, all partnership debts, liabilities, claims, and obligations shall be paid or otherwise satisfied from partnership assets."
Release of Claims
This section of the agreement provides that neither party shall have any further claims against the other, once the agreement is executed and any required payment is remitted.
Governing Law
A governing law clause is recommended in all legal documents and should specify the controlling jurisdiction. Typically, the governing law clause contains the following language:
"This Agreement shall be interpreted in accordance with the laws of the State of [insert state]."
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Mistakes to Avoid in a Partnership Dissolution Agreement
Many businesses make errors when it comes to deciding their partnership dissolution at the end of a business relationship. It’s important to leave nothing out and avoid the following mistakes:
-Failure to Follow State Requirements: All states have specific laws regarding the dissolution of a partnership. Know the requirements and make sure your contract regarding the process meets those requirements and is signed by all partners.
-Confusing Contract Signatures: Any contract regarding the dissolution of a partnership needs to be straight to the point. Make it clear who is signing what and where, and request that all signatures be made on the same page so that this is very clear.
-Speaking for All Partners: Some partnership contracts involve legal language written by one partner and many times, that partner will attempt to speak for the entire group. Make it clear that every individual must sign the binding resolution of dissolution for it to be valid. Otherwise, it should be clearly stated that they are representing the entire partnership and have full authority to terminate it.
-Boundless Language: A sales agreement, merger agreement, or buy-sell agreement should all use language that is very clearly defined and understood. Unclear language could open your business up to future legal issues, so make sure to avoid clever words and phrases covered in legalese from the beginning.
-Permanent Language: The dissolution of a partnership should be permanent, but some agreements accidentally indicate otherwise. Make sure to go through every word to ensure that there are no loopholes that would make it seem like the partnership is still active in any way. Words like "possibly," "potentially," and "would" should not be used in this document.
When to Consult an Attorney
Connection and communication are essential for the success of any relationship. This holds doubly true for business partnerships. When these dissolutions occur, it is important that business partners present a united front, at least for the sake of their clients, partners, and workers. However, this does not mean that you should think that mutual respect and civility will prevent legal complications from occurring. Consultations with a qualified legal professional are often necessary to ensure that your rights are protected, regardless of whether it is your decision to file for dissolution or that of the other business partner.
There are many additional issues associated with a business partnership dissolution, from the division of shared assets to the responsibilities of both parties. While many disputing partners are able to amicably negotiate, neither side should receive legal advice from the other party’s attorney . This can only result in resentment, frustration and potential legal repercussions. If you are involved in a partnership dissolving, even if you are experiencing no disputes with your co-partner, you need to speak with a lawyer before attempting to negotiate any dissolution terms.
Even amicable breakup negotiations can fall apart later, particularly those involving small businesses and other active partnerships. You may believe your partnership is completely dissolved when it is not. You may miss additional outstanding issues that could be resolved through mediation or arbitration. You may even find that your business partner has hired an attorney in secret. Don’t let your best intentions allow your business to become your worst nightmare; consult a lawyer as soon as possible to get the facts on your situation.