BM1905

DISSOLUTION AND WINDING UP

Basic Terms
When a partnership ends, it involves three (3) stages:
1. Dissolution – Change in the relation of the partners caused by any partner ceasing to be associated in the
carrying on of the business; partnership is not terminated but continues until the winding up of partnership
affairs is completed.
2. Winding Up – The process of settling the business or partnership affairs after dissolution.
3. Termination – That point when all partnership affairs are completely wound up and finally settled. It signifies
the end of the partnership life.
Dissolution
Types of Dissolution
A. Extrajudicial dissolution
This refers to the termination of a partnership’s existence that is effected outside the course of regular
judicial proceedings.
Causes of Extrajudicial Dissolution
1. Without violation of the agreement between partners
a. By termination of the definite term/particular undertaking specified in the agreement
b. By the express will of any partner, who must act in good faith, when no definite term or particular
undertaking is specified
c. By the express will of all the partners who have not assigned their interest/charged them for their
separate debts, either before or after the termination of any specified term or particular undertaking
d. By the bona fide expulsion of any partner from the business in accordance with power conferred by
the agreement
2. In contravention of the agreement between the partners, where the circumstances do not permit a
dissolution under any other provision of this article, by the express will of any partner at any time
3. By any event which makes it unlawful for business to be carried on/for the members to carry it on for
the partnership
4. Loss of specific thing promised by partner before its delivery
5. Death of any partner
6. Insolvency of a partner/partnership
7. Civil interdiction of any partner
8. Decree of court under Article 1831

B. Judicial dissolution
This refers to the termination of a partnership’s existence handled by the courts located within the state of
the company’s incorporation. A dissolution may be obtained when the attorney general of the state of the
incorporation petitions for it due to a company’s failure to comply with regulations of tax laws, administration
or statutory regulations.
Grounds for Dissolution by Decree of Court (Article 1831)
1. Partner declared insane in any judicial proceeding or shown to be of unsound mind
2. Incapacity of partner to perform his part of the partnership contract
3. Partner guilty of conduct prejudicial to business of partnership
4. Willful or persistent breach of partnership agreement or conduct which makes it reasonably
impracticable to carry on partnership with him
5. Business can only be carried on at a loss.
6. Other circumstances which render dissolution equitable

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On the application by purchaser of partner’s interest

• After termination of specified term/particular undertaking

• Anytime if partnership at will when interest was assigned/charging order issued
Effects of Dissolution
A. Authority of Partner to Bind Partnership
General rule: All authority of partners to bind partnership is terminated.
Exceptions:
1. Acts necessary to wind up partnership affairs
2. Acts necessary to complete transactions begun but not finished
Qualifications:
1. With respect to partners
a. Dissolution is not by ACT, DEATH or INSOLVENCY (ADI) of a partner, the authority of partners
to bind partnership by new contract is immediately terminated (Article 1833).
b. If due to ADI, authority of partners inter se to act for the partnership is not deemed terminated.
Each partner is liable to his co-partners for his share of any liability created by any partner
acting for the partnership as if partnership is not dissolved.

Exceptions to (a):
i. If cause of dissolution is the ACT of a partner and the acting partner have knowledge of
such dissolution
ii. If cause of dissolution is the DEATH or INSOLVENCY of a partner and the acting partner
had knowledge or notice of such dissolution

2. With respect to third persons

The partnership is generally bound by new contract although authority of acting partner is already
deemed terminated but the innocent partners can recover from the guilty partners.

a. When partnership is bound to third persons even after dissolution (Article 1834):
i. Transactions in connection to winding up partnership affairs
ii. Acts for completing unfinished transactions
iii. Any transaction which would bind the partnership if dissolution had not taken place provided
the other party is in good faith, meaning:
1. Previous creditor and he had no knowledge or notice of the dissolution
2. Not a previous creditor and the fact of dissolution had not been published in a
newspaper of general circulation

b. When partnership is not bound to third persons after dissolution (Article 1834):
i. Where dissolution is due to unlawfulness to carry on with business (exception: winding up
of partnership affairs)
ii. Where the acting partner in the transaction has become insolvent
iii. Where partner is unauthorized to wind up partnership affairs, except by transaction with
one who is:
1. A previous creditor and he had no knowledge or notice of the dissolution
2. Not a previous creditor and the fact of dissolution had not been published in a
newspaper of general circulation
iv. Where act is not appropriate for winding up or for completing unfinished transactions
v. Completely new transaction which would bind the partnership if dissolution had not taken
place with third persons in bad faith

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Notice of dissolution
1. Person had extended credit prior to dissolution – They must have knowledge or notice of
dissolution.
2. Persons who had known of partnership existence – Publication is sufficient.

B. Discharge of Liability
General rule: Dissolution does not automatically discharge existing liability of partner.
Exception: A partner may be relieved from all existing liabilities upon dissolution only by an agreement
between:
1. Partner concerned
2. Person/partnership continuing the business
3. Partnership creditors
Rights of a partner upon dissolution
1. Dissolution is not in contravention of the partnership agreement:
a. Have partnership property applied to discharge liabilities of partnership
b. Receive in cash his share of the surplus

2. Dissolution is in contravention of the partnership agreement:

A. Partner who did not cause dissolution wrongfully
i. To have partnership property applied to discharge liabilities of partnership
ii. To receive in cash his share of the surplus
iii. To be indemnified for damages caused by partner guilty of wrongful dissolution
iv. To continue business in same name during agreed term of the partnership, by themselves
or jointly with others
v. To possess partnership property if business is continued

B. Partner who wrongly caused dissolution

i. If business not continued by others
a. To have partnership property applied to discharge liabilities of partnership
b. Receive in cash his share of surplus less damages caused by his wrongful dissolution

ii. If business continued by others

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

3. Where partnership contract is rescinded on ground of fraud or misrepresentation:

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

C. Winding Up

Manner of winding up
1. Extrajudicial - By the partner themselves without court intervention
2. Judicial - Under the control and direction of the court upon proper cause shown by any partner,
his legal representatives of his assignee

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Persons authorized to wind up

1. Partners designated by the agreement
2. In absence of agreement, all partners who have not wrongfully dissolved the partnership
3. Legal representative of last surviving partner not insolvent

The court, at its discretion, may appoint a receiver to wind up the partnership affairs where such step
is shown to be the best interest of all persons concerned.

Powers of liquidating partner

1. Make new contracts but merely for liquidation purposes.
2. Raise money to pay partnership debts.
3. Incur obligations to complete existing contracts or preserve partnership assets.
4. Incur expenses necessary in the conduct of litigation.

Assets of the partnership during winding up

1. Partnership property (including goodwill)
2. Contributions of the partners necessary for the payment of all liabilities enumerated under Article
1839, paragraph 2
Order of payment of liabilities in winding up
1. Partnership creditors other than partners
2. Partners as creditors
3. Partners as investors - Return of capital contribution
4. Partners as investors - Share of profits if any

Doctrine of marshaling of assets

Partnership creditors have preference in partnership assets:
1. Separate or individual creditors have preference in separate or individual properties
2. Anything left from either goes to the other

D. Dissolution of Partnership by Change in Membership

Article 1840. In the following cases, creditors of the dissolved partnership are also creditors of the person
or partnership continuing the business:

(1) When any new partner is admitted into an existing partnership, or when any partner retires and
assigns (or the representative of the deceased partner assigns) his rights in partnership property to
two or more of the partners, or to one or more of the partners and one or more third persons, if the
business is continued without liquidation of the partnership affairs;
(2) When all but one partner retire and assign (or the representative of a deceased partner assigns) their
rights in partnership property to the remaining partner, who continues the business without liquidation
of partnership affairs, either alone or with others;
(3) When any partner retires or dies and the business of the dissolved partnership is continued as set
forth in Nos. 1 and 2 of this article, with the consent of the retired partners or the representative of the
deceased partner, but without any assignment of his right in partnership property;
(4) When all the partners or their representatives assign their rights in partnership property to one or
more third persons who promise to pay the debts and who continue the business of the dissolved
partnership;

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

E. When Business of Dissolved Partnership is Continued

1. Creditors of old partnership are also creditors of the new partnership which continues the business of
the old one w/o liquidation of the partnership affairs.
2. Creditors have an equitable lien on the consideration paid to the retiring /deceased partner by the
purchaser when retiring/deceased partner sold his interest w/o final settlement with creditors.
3. Rights if retiring/estate of deceased partner:
a. To have the value of his interest ascertained as of the date of dissolution
b. To receive as ordinary creditor the value of his share in the dissolved partnership with interest or
profits attributable to use of his right, at his option

F. Rights of Retiring, or of Estate of Deceased Partner when Business is Continued

1. Have the value of the interest of the retiring or deceased partner ascertained as of the date of
dissolution, i.e. retirement or death.
2. Receive, as an ordinary creditor, an amount equal to the value of his share in the dissolved
partnership with interest, or, at his option, in lieu of interest, the profits attributable to the use of his
right in the property of the dissolved partnership.

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

G. Partner’s Lien
Right of every partner to have the partnership property applied to discharge partnership liabilities and to
have the surplus assets, if any, distributed in cash to the respective partners after deducting what may be
due to the partnership from them as partners.

Article 1842. The right to an account of his interest shall accrue to any partner, or his legal representative
as against the winding up partners or the surviving partners or the person or partnership continuing the
business, at the date of dissolution, in the absence of any agreement to the contrary.

The above article speaks of accounting to be done upon dissolution of the partnership, while Article 1809
refers to accounting before dissolution by reason of the circumstances mentioned in the article.

Partners liable to render an account

1. The winding up partners
2. The surviving partners
3. The person or partnership continuing the business

REFERENCES:
De Leon, H.S. & De Leon Jr., H.M. (2014). Comments and cases on partnership, agency, and trusts (9th ed.).
Manila: REX Book Store.
What is EXTRAJUDICIAL? (n.d.). Retrieved from https://thelawdictionary.org/extrajudicial/ on June 7, 2019
What is judicial dissolution? (n.d.). Retrieved from http://www.businessdictionary.com/definition/judicial-
dissolution.html on June 7, 2019

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