The liquidation of a limited liability partnership means winding up the partnership by realizing the noncash assets, paying the liabilities, and distributing the remaining cash to the partners. Liquidation may be completed quickly, or it may require several months. The term realization means the conversion of assets to cash.
When partners decide to liquidate their limited liability partnership, the partnership's accounting records are adjusted, and the net income or loss for the final period of operations is entered in the partners' capital accounts. Gains or losses on the realization of assets, divided among the partners in the income-sharing ratio, also are entered in the partners' capital accounts.
After all noncash assets are realized and partnership creditors are paid, partners receive cash payments equal to the balances of their capital accounts. If the cash generated from the realization of noncash assets is insufficient to pay the liabilities, unpaid partnership creditors may collect unpaid liabilities from the personal assets of any solvent partner whose actions caused the partnership's insolvency, even from partners who have debit balances in their capital accounts.
If the realization of assets is completed before any cash is paid to the partners, the final gain or loss on the realization of assets is known and is allocated to partners' capital accounts. In such cases, the available cash is paid to creditors and then to partners according to the balances of their capital accounts. Deficits in the capital accounts of any of the partners must be eliminated through additional investments by the affected partners. However, if a deficit partner is insolvent, the deficit must be absorbed by the other partners in their income-sharing ratio.
If the realization of assets has not been completed, and the final gain or loss on realization of assets is not known, cash may be distributed to partners in installments as long as sufficient cash is withheld to cover any unpaid liabilities and possible costs of liquidation. The amount of cash that may be paid to partners at various stages of liquidation is determined by preparation of an exhibit in which partners' capital accounts are charged for the maximum possible loss (including liquidation costs) that may be incurred in winding up the limited liability partnership.
In the course of liquidation, partners may withdraw assets in kind. No distribution of cash or other assets should be made to partners until after all possible losses and liquidation costs have been considered. Each interim payment of cash to partners is made on the assumption that it may be the last, that is, that no additional cash will be available for partners.
Although partners' loans to the partnership theoretically should be repaid before partners' capitals, the right of offset requires that loan balances be added to the capital account balances for liquidation purposes. The fact that a partner has made a loan to the partnership does not mean that the partner will receive cash any sooner on liquidation. Thus, in a statement of realization and liquidation, loan and capital account balances may be combined for each partner. However, loan and capital account balances are not combined in the partnership ledger.
The income-sharing ratio used during the operation of a limited liability partnership also is generally applicable to the gains and losses during liquidation. However, the partners may agree to distribute liquidation gains and losses in a different ratio. When all liquidation gains and losses are allocated to the partners' capital accounts, the amount of cash available (after payment of liabilities) is equal to the total of the balances of the partners' capital and loan accounts. Cash then is distributed to the partners in amounts equal to the total amount of each partner's capital and loan accounts.
In an insolvent limited liability partnership, at least one partner has a capital deficit. At this point in the liquidation process, partnership creditors may demand payment from any solvent partner whose actions caused the partnership's insolvency. Payments to partnership creditors by a partner from personal funds are recorded by debits to partnership liability accounts and a credit to the partner's capital account. If the partner with the capital deficit pays the required amount, sufficient cash will be available to pay the partnership creditors in full.
When both a limited liability partnership and some of the partners are insolvent, the legal rule of marshaling of assets is applied. This rule states that creditors of each partner have first claim on his or her personal assets, and partnership creditors have first claim on partnership assets. Any amounts payable to creditors of an insolvent limited liability partnership that has no assets may be obtained from one or any combination of the solvent partners whose actions caused the partnership's insolvency. Any partner who is forced to invest in the partnership more than originally agreed on has a right to collect from the other partners. However, if the other partners were insolvent, this would be a meaningless right. The creditors of an insolvent partner may claim only that partner's equity interest, if any, in the partnership.
To illustrate the marshaling of assets, assume that, after the realization of all the noncash assets of Apto, Bart & Capp LLP, liabilities of $15,000 remain unpaid. Assume the following financial status for each partner:
Partnership capital (deficit)
Net personal assets (deficit)
Partner Apto
$15,000
$30,000
Partner Bart
(12,500)
5,000
Partner Capp
(17,500)
(2,500)
The partnership creditors can recover the entire $15,000 from Apto only if Apto's actions caused the partnership's insolvency. If Bart was the cause, partnership creditors would receive only $5,000 of their $15,000 total claims. The personal creditors of Capp could not proceed against the personal assets of either Apto or Bart, and they would not receive anything from the partnership because Capp has a capital deficit.
When the liquidation of a limited liability partnership is expected to extend over several months, partners usually will want to receive cash (or other assets) as soon as possible. Installment payments to partners may be made if precautions are taken to ensure that all creditors are paid in full and that no partner is paid prematurely.
In installment liquidations, the liquidator must not authorize distributions to partners that may have to be returned by the partners if large liquidation losses cause deficits in their partnership equity (capital plus loan accounts). Installment distributions of cash or other assets to partners are determined as follows:
Assume a total loss on the realization of all remaining noncash assets.
Assume that any partner with a potential capital deficit will be unable to pay anything to the partnership from personal assets.
To implement these assumptions, installment cash payments to partners are made as if no more cash would become available, either from the realization of assets or from the collection of any potential capital deficits.
When installment distributions to partners are made according to the rules listed in paragraph 13, the effect will be to bring the partners' equities to the income-sharing ratio as quickly as possible. After installment distributions to partners have reduced the partners' equities to the income-sharing ratio, subsequent distributions of cash or other assets to partners may be made in the income-sharing ratio.
A complete cash distribution program may be prepared before liquidation starts. The procedures to be followed in the preparation of such a program are as follows:
Ascertain the equity (capital, plus any loan to the partnership, less any loan from the partnership) for each partner.
Divide the equity of each partner by each partner's income-sharing ratio to determine the capital per unit of income sharing for each partner.
The partner with the largest capital per unit of income sharing is entitled to receive enough cash to reduce his or her capital per unit of income sharing to the capital of the partner with the second highest amount. The amount of cash to be paid at this point is computed by multiplying the required reduction in the capital per unit of income sharing of the highest-ranking partner by that partner's income-sharing ratio.
The process described in c is continued until the capital per unit of income-sharing amounts for all partners are equal. Additional cash distributions then may be made in the income-sharing ratio.
Partners Ray, Sam, and Tom share net income and losses in the ratio of 4:3:2, and have total equities in the limited liability partnership as follows: Ray, $16,000; Sam, $10,500; and Tom, $6,020. How should cash or other assets be paid to the partners (after all liabilities have been paid) as they become available in the course of liquidation? The answer may be developed as follows:
Ray
Sam
Tom
Capital balances (equities) before liquidation
$16,000
$10,500
$ 6,020
Income-sharing ratio
4
3
2
Capital per unit of income sharing
$ 4,000
$ 3,500
$ 3,010
First cash of $2,000 ($500 x 4 = $2,000) to Ray
(500)
Capital per unit of income sharing
$ 3,500
$ 3,500
$ 3,010
Next $3,430 to Ray and Sam: $490 x 4 or $1,960 to
Ray, and $490 x 3 or $1,470 to Sam
(490)
(490)
Capital per unit of income sharing
$ 3,010
$ 3,010
$ 3,010
Any cash in excess of $5,430 may be paid to Ray,
Sam, and Tom in the 4:3:2 ratio.
After cash or other assets of $5,430 are distributed to the partners as computed above, the actual capital account balances would be in the income-sharing ratio of 4:3:2, as follows: Ray, $12,040; Sam, $9,030; and Tom, $6,020.
In some cases, the liquidator may elect to set aside cash to pay any remaining liabilities and potential liquidation costs and distribute any residual cash to partners according to the program described in paragraph 15.
The Uniform Limited Partnership Act provides that after outside creditors of a liquidating limited partnership have been paid, the equities of the limited partners must be paid before the general partner or partners may receive any cash. Also, the limited partners may agree that one or more of them may have priority over the others regarding payments in liquidation of the limited partnership.
If a limited liability partnership is incorporated, the net assets of the partnership must be restated to current fair values before they are transferred to the corporation. This assures that the capital stock of the corporation will be distributed to the partners in the ratio of their respective equities in the partnership. The accounting records of the partnership may be modified and continued in use by the corporation, but usually a new set of accounting records is established for the corporation.
A joint venture differs from a limited liability partnership in that it generally is limited to carrying out a single project. Joint ventures may be created for such purposes as to develop a tract of land, sell agricultural products, explore for natural resources, or undertake construction projects.
A corporate joint venture is a corporation owned and operated by a small group of joint venturers as a separate business enterprise. The investment in the common stock of a corporate joint venture is accounted for by the equity method of accounting. Supplementary disclosure of assets, liabilities, and results of operations of the corporate joint venture is made in a note to the financial statements of each venturer if the investment in the venture is material.
Either the equity method of accounting or the proportionate share method of accounting may be used for an investment in an unincorporated joint venture. In the proportionate share method of accounting, the investor recognizes in its accounting records its share of each asset, liability, revenue, and expense of the joint venture.
