In a partnership, two or more individuals jointly own and operate an unincorporated business. The liability of any partner depends upon the type of partnership that the parties have entered into. A general partnership, which will be the focus below, is a joint business operated by two or more parties who do not elect to a specific type of partnership (such as a limited partnership). In a general partnership, each partner is personally liable for the debts of the partnership entity. Essentially, if the entity defaults on its obligations, creditors can seek the personal assets of the partners to satisfy these debts. When the partnership can no longer operate its business due to outstanding liabilities, it may liquidate the business by filing for bankruptcy.
Partnerships, like individuals, are permitted to file for bankruptcy under Chapter 7. In contrast to an individual bankruptcy, a partnership’s assets are distributed to creditors in full to satisfy outstanding debts. A partnership cannot be discharged in a Chapter 7 bankruptcy; the bankruptcy ceases once all the assets are liquidated and dispersed. In the event the entity cannot satisfy the debts of all the partnership’s creditors, the creditors may seek to capture the assets of a partner in a general partnership. The bankruptcy trustee also has the authority to bring action against the partners individually to capture any shortfall in the repayment of liabilities to the affected creditors.
In a Chapter 7 bankruptcy, the process of liquidation is streamlined and simplified. When bankruptcy is filed, a trustee is appointed to distribute all the debtor’s assets, usually to multiple creditors. Thus, individual partners do not have to divide assets and handle payments to a variety of creditors. However, the trustee may sell assets for less than their fair market value in order to expedite the process. Partners in a bankruptcy should consider whether they have sufficient assets to pay creditors themselves so as to retain the full value of their assets.
Filing for Chapter 7 bankruptcy also has significant drawbacks in a partnership insolvency. The partnership cannot be discharged in bankruptcy. Once the bankruptcy is completed, the partnership ceases to exist. The assets are liquidated and the partnership is barred from doing business. Most importantly, general partners are at risk of being sued to cover the debts that cannot be satisfied by the existing assets of the partnership.
Contact Shane Coons at 949-333-0900 or visit his website at www.ShaneCoonsLaw.com to find out more about his practice.