What happens in the event of losses to my business?

Lets say you started a business, and things aren’t going so well.  You may or may not have been involved in the decisions that lead to the losses of the company.  What is the general rule for losses? Is the partner who made the bad decisions responsible for the losses or are they going to be shared?  The general rule, under the Revised Uniform Partnership Act, is that each partner is entitled to an equal share of the partnership profits and is chargeable with a share of partnership losses in proportion to the partner’s share of the profits. See RUPA § 401(b).

 

This means that if your business is winding down, there is an order in which liabilities should be paid, per § 40 of the Uniform Partnership act: 1) liabilities to creditors (other than partners, 2) liabilities to partners (other than capital and profits), 3) liabilities to partners for capital, and 4) liabilities to partners for profits.  Thus, partners would have to come up with money to pay creditors for losses not covered by the business, in the same proportion to which they would receive profits.

 

What does that mean? Well let’s say Jane and John are partners, but not equal partners.  John put up the money for the business, and Jane manages it.  She gets only gets 40% of the profits, and John keeps 60% of the profits because of his investment in the company.  Applying § 401(b), if the company is winding down, and they are still short $100,000 to pay short term loans, then John would be responsible for $60,000 and Jane would be responsible for $40,000, as that matches what each would get had it been $100,000 in profits.

 

It would follow then, that Jane could be liable to John for some of the losses.  She would have to pay him money in order to wind down the business.

 

However, there is also case law out there which says that partners, in the situation such as John and Jane are in, are not liable to the other for contribution for any loss sustained.  This means that when the company loses money, John, who contributed the money, is not entitled to recover any part of it from Jane, who contributed only services.  Each party then looses their own capital.  Jane loses her labor, and John loses his money.

 

This type of situation illustrates the need for defining these terms in the Partnership or Operating Agreement before your business gets started.  Consult with local counsel in order to determine what your jurisdiction says regarding these rules and you options for contracting around the default rules.

 

Photo By: Moyan Brenn