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1.5.1) Marshaling of Assets Doctrine and Liquidation of A Partnership

1) The marshaling of assets doctrine dictates that when a partner declares bankruptcy, their personal creditors must first be paid out of the partner's personal assets. Any remaining assets can then be used to pay partnership creditors. 2) When a partnership is liquidated, the uniform partnership act states that partnership creditors should be paid first, followed by any loans partners made to the partnership. However, the right to offset doctrine allows a partner's loan balance to be reduced by any deficits in their capital account during liquidation. 3) A partner may choose to receive certain non-cash partnership assets, like office furniture or computers, instead of having them converted to cash during liquidation.

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0% found this document useful (0 votes)
742 views5 pages

1.5.1) Marshaling of Assets Doctrine and Liquidation of A Partnership

1) The marshaling of assets doctrine dictates that when a partner declares bankruptcy, their personal creditors must first be paid out of the partner's personal assets. Any remaining assets can then be used to pay partnership creditors. 2) When a partnership is liquidated, the uniform partnership act states that partnership creditors should be paid first, followed by any loans partners made to the partnership. However, the right to offset doctrine allows a partner's loan balance to be reduced by any deficits in their capital account during liquidation. 3) A partner may choose to receive certain non-cash partnership assets, like office furniture or computers, instead of having them converted to cash during liquidation.

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1.5.

1) Marshaling of Assets Doctrine and Liquidation of a Partnership


Personal bankruptcy is not uncommon and raises questions as to the legal right that damaged
partners have to proceed against an insolvent partner. Where a partner has become bankrupt or
his estate is insolvent the claims against his separate property shall rank in the following order:
1. Those owing to separate creditors (personal liabilities)
2. Those owing to partnership creditors (business creditors)
3. Those owing to partners by way of contribution (to other partners as a result of deficit
capital)
This principle is called principle of marshalling of assets. According to the marshaling of
assets doctrine, personal liabilities have first priority. After these claims have been satisfied, the
remaining assets should be used to remunerate any partnership creditors who have sought
recovery directly from the partner.

Example 1.17: Insolvency (Partner is Insolvent)


Balance Sheet
Cash........................................... Br 30,000 Liabilities................................... Br 80,000
Non-cash Assets......................... 150,000 ABLE, Capital (40%)................. 15,000
BAKER, Capital (30%).............. 40,000
CANNON, Capital (20%).......... 30,000
______ DUKE, Capital (10%)................ 15,000
Total Assets............................... 180,000 Total Liabilities and Capital....... 180,000

Additional Information:
 BAKER is insolvent & personal creditors file Br 30,000 claim against this partner’s share
of partnership property.
 Non-cash assets are sold for Br 100,000 (the book value is Br 150,000)
 Partnership liabilities of Br 80,000 are then paid
 An additional Br 5,000 should be forthcoming from ABLE to eradicate the single
negative balance. This raises cash to Br 55,000 (30,000 + 20,000 + 5,000). The
liquidation losses reduce Baker’s capital below Br 30,000 therefore; Baker’s creditors
will get only Br 25,000 despite the remaining Br 5,000 debt. No further claim against the
business.

ABLE BAKER CANNON DUKE


(40%) (30%) (20%) (10%)
Beginning Capital..........................................
15,000 40,000 30,000 15,000
Loss on Realization........................................
(20,000 (15,000) (10,000) (5,000)
)
Capital Balances.............................................
(5,000) 25,000 20,000 10,000
Contribution by ABLE................................... 5,000 –0– –0– –0–
Final Capital Balances...................................-0- 25,000 20,000 10,000

Payment of Liabilities:
Liabilities (Partnership Liabilities)...............................80,000
Cash..................................................................... 80,000
Distribution of Cash to Partners:
BAKER, Capital (Creditors of BAKER)......................25,000
CANNON, Capital........................................................20,000
DUKE, Capital..............................................................10,000
Cash.................................................................... 55,000

Example 1.18: Insolvency (Partner is insolvent)


Balance Sheet
Cash...........................................Br 10,000 Liabilities...................................Br 70,000
Non-cash Assets......................... 140,000 MORRIS, Capital (40%)............ 15,000
NEWTON, Capital (20%).......... 10,000
OLSEN, Capital (20%).............. 23,000
PRINCE, Capital (20%)............. 32,000
Total Assets............................... 150,000 Total Liabilities and Capital....... 150,000
 The non-cash assets are sold for a total of Br 80,000 and all liabilities paid

Realization of Non-cash Assets:


Cash...........................................................................80,000
MORRIS, Capital (40%)...........................................24,000
NEWTON, Capital (20%).........................................12,000
OLSEN, Capital (20%)..............................................12,000
PRINCE, Capital (20%)............................................12,000
Non-Cash Assets (Or Specific Accounts)........ 140,000
Payment Liabilities:
Liabilities...................................................................
70,000
Cash................................................................. 70,000

The capital accounts for MORRIS and NEWTON report negative capital balances of Br 9,000
(Br 15,000 – Br 24,000) and Br 2,000 (Br 10,000 – 12,000), respectively.
 NEWTON is personally solvent
 MORRIS’s personal financial condition does not allow him for any further contribution
Absorbing loss from Morris’s Capital deficit:
NEWTON, Capital (1/3)...............................................3,000
OLSEN, Capital (1/3)....................................................3,000
PRINCE, Capital (1/3)..................................................3,000
MORRIS, Capital................................................ 9,000
Newton’s Cash Contribution
Cash ..............................................................................5,000
NEWTON, Capital.............................................. 5,000

Statement of Partners’ Capital balances


Statement of Partners’ Capital balances
Cash MORRIS NEWTON OLSEN PRINCE
Capital Capital Capital Capital
Beginning Balance................. 10,000 15,000 10,000 23,000 32,000
Sold Assets............................. 80,000 (24,000) (12,000) (12,000) (12,000)
Paid Liabilities....................... (70,000) -0- -0- -0- -0-
Insolvency of MORRIS......... -0- 9,000 (3,000) (3,000) (3,000)
Contribution by NEWTON.... 5,000 -0- 5,000 -0- -0-
Closing Balances.................... 25,000 -0- -0- 8,000 17,000

Example 1.19: Insolvency (Partnership is Insolvent)


Liabilities......................................................................Br 20,000
KELLER, Capital.......................................................... (30,000)
LEWIS, Capital............................................................. (5,000)
MORGAN, Capital....................................................... 5,000
NORRIS, Capital.......................................................... 10,000

Additional Information:
 Personal financial condition
KELLER LEWIS MORGAN NORRIS
Capital Capital Capital Capital
Personal Assets...............................25,000 56,000 26,000 150,000
Personal Liabilities.........................45,000 56,000 29,000 60,000
 Keller is personally insolvent thus the deficit is written-off
 Loss or profit is shared equally

Statement of Partners’ Capital balances


KELLER LEWIS MORGAN NORRIS
Capital Capital Capital Capital
Beginning Balance..........................
(30,000) (5,000) 5,000 10,000
Capital Contribution........................ 0 0 0 20,000
Written off deficit balance..............30,000 (10,000) (10,000) (10,000)
Closing Balances............................. -0- (15,000) (5,000) 20,000

Right to Offset Doctrine and Liquidation of a Partnership


The uniform partnership, set lists the order for distribution of cash by a liquidating partnership as
1. Payment of creditor in full (partnership creditors)
2. Payment of loans from partners, and
3. Payment of partner’s capital credit balances
The indicated priority of partners’ loans over partners’ capital appears to be a legal fiction. This
rule is nullified for practical purposes by an established legal doctrine called the Right to Offset.
The Right to Offset doctrine stated that if a partner’s capital account has a debit balance (or
even a potential debit balance depending on possible future realization losses, any credit
balance in that partner’s loan account must be offset against the deficit (or potential deficit) in
the capital account. A partner may choose to receive certain non-cash assets, such as computers
or office furniture, in kind, rather than to convert such property to cash. Regardless of whether
non-cash assets are distributed by partners, it is imperative to follow the rule no distribution of
assets must be made to partners until all outside partnership creditors have been paid in full.
There are two groups of creditors; (1) creditors of the partnership and 2) creditors of the partners.
The relative rights of these two groups of creditors are governed by the provisions of the
Uniform Partnership Act (UPA) which was relating to the Marshaling of Assets. These rules
provide that assets of the General Partnership (including partners’ deficits) are first available to
creditors of the partnership and that assets of the partners’ are first available to their creditors.

Example 1.20: AREGA and BELAY have been running a partnership together for a number of
years. The partnership had the following balance sheet on June 30, 200
AREGA and BELAY Partnership
Balance Sheet
June 30, 2000
Cash........................................... Br 10,000 Liabilities...................................Br 20,000
Other Assets............................... 75,000 Loan Payable to AREGA........... 20,000
AREGA, Capital (50%)............. 40,000
BALAY, Capital (50%)............. 5,000
Total Assets............................... 85,000 Total Liabilities and Capital....... 85,000
Instruction: Determine partners’ final capital balances assuming that the assets are sold at Br
35,000 and in accordance with the Right to offset Doctrine.
AREGA and BALAY Partnership
Statement of Partners’ Capital and Cash Balances
June 30, 2000
AREGA BALAY
Cash
Capital Capital
Beginning Balance....................................................
10,000 40,000 5,000
Loan Account ( + Loan from & - Loan to)............... –0– –0– 20,000
Adjusted Capital Balances........................................ 10,000 40,000 25,000
Assets sold................................................................
35,000 (20,000) (20,000)
Balances....................................................................
45,000 20,000 5,000
Payment of liabilities................................................
20,000 –0– –0–
Final Balances..........................................................
25,000 20,000 5,000

Example 1.21:
RICH, SAND & TOLL Partnership
Balance Sheet
June 30, 2000
Cash........................................... Br 10,000 Liabilities...................................Br 60,000
Loan to Toll............................... 5,000 Loan from Sand......................... 5,000
Other Assets............................... 100,000 Rich, Capital.............................. 5,000
Sand, Capital.............................. 10,000
Toll, Capital............................... 35,000
Total Assets............................... 115,000 Total Liabilities and Capital....... 115,000

Additional Information:
Partner Personal Assets Personal Liabilities
RICH 100,000 25,000
SAND 50,000 50,000
TOLL 40,000 60,000
Instruction: Determine partners’ final capital balances assuming that:
 Other assets are sold for Br 40,000
 Marshalling of assets doctrine
 Right to offset doctrine
 Equal sharing of profit or loss

RICH, SAND & TOLL Partnership


Statement of Cash and Partners’ Capital Balances
June 30, 2000
Rich Sand Toll
Cash
Capital Capital Capital
Beginning Balance.............................................. 10,000 5,000 10,000 35,000
± Loan Account.................................................. –0– –0– 5,000 (5,000)
Adjusted Balance................................................ 10,000 5,000 15,000 30,000
Assets sold.......................................................... 40,000 (20,000) (20,000) (20,000)
Balances.............................................................. 50,000 (15,000) (5,000) 10,0000
Writing off Sand’s Capital balances................... –0– (2,500) 5,000 (2,500)
Balances.............................................................. 50,000 (17,500) –0– 7,500
Contribution by Rich.......................................... 17,500 17,500 –0– –0–
Balances.............................................................. 67,500 –0– –0– 7,500
Payment of Liabilities......................................... 60,000 –0– –0– –0–
Balances 7,500 –0– –0– 7,500
Distribution of cash to partners........................... (7,500) –0– –0– (7,500)
Final Balances..................................................... –0– –0– –0– –0–

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