Chapter 3: Dissolution and Winding Up

Dissolution – A change in the relationship between partners when one partner ceases to be associated with the
business. It marks the end of business operations but not the partnership itself.
Winding Up – The process of settling business affairs after dissolution.
Termination – The final stage when all partnership affairs are settled, marking the official end of the partnership

Dissolution Does Not Mean Termination

The partnership still exists until all affairs are settled.
No new business should be undertaken after dissolution—only liquidation and distribution
Dissolution ≠ Business suspension – A dissolved partnership cannot simply resume; it must be reformed.
Important Legal Principle
Art. 1829 – A dissolved partnership continues to exist until the winding-up process is completed.
Causes of Partnership Dissolution (Art. 1830) Causes of Partnership Dissolution

Without Agreement Violation: ➢ By Agreement Violation: Voluntary

1. End of the agreed term or specific undertaking. (partner’s will) or involuntary (by law).
2. Any partner’s good faith withdrawal (if no term is
➢ By Will of Partners: One, more, or all
set).
3. Mutual agreement of all partners. partners may dissolve (Art. 1830).
4. Expulsion of a partner as per agreement. ➢ By Law: Events beyond partners’ control
(e.g., illegality, death, insolvency).
With Agreement Violation:
5. Any partner’s unilateral decision. ➢ Extrajudicial vs. Judicial: Most causes
dissolve automatically (Art. 1830), but
Other Causes:
some require a court decree (Art. 1831).
6. Business becomes illegal.
7. Loss of a partner’s promised contribution. ➢ New Partnership: Dissolved partners
8. Death of a partner. may form a new one under the same
9. Insolvency of a partner or the partnership.
10. Civil interdiction of a partner.
terms.
11. Court decree.
Dissolution Without Violation of Dissolution in Contravention of
Agreement Agreement
1. By Any Partner’s Will – A partner
1. End of Term or Undertaking – The
partnership automatically dissolves when may withdraw at any time, even
the agreed period or project ends. against the agreement, causing
2. Partner’s Express Will – Any partner dissolution.
can dissolve a partnership at will, provided
2. Power vs. Right – A partner always
they act in good faith.
3. Mutual Agreement – All partners has the power to dissolve but may not
(except those who assigned their interests have the right under the agreement.
or debts) must unanimously agree to 3. Legal Consequences – The
dissolve.
withdrawing partner may be liable for
4. Expulsion of a Partner – Must be in
good faith and based on the agreement; damages but cannot be forced to stay.
wrongful expulsion may lead to damages.
 Loss of Specific Contribution in a
Dissolution Due to Illegality Partnership
1. Loss Before Delivery – If a specific thing to
Occurs when a supervening event makes be contributed is lost before delivery, the
the business or partnership unlawful (e.g., partnership is dissolved due to failure of
new law, war, legal restrictions). contribution.
A partnership must always have a lawful 2. Loss After Delivery – If lost after delivery,
purpose (Art. 1770). the partnership retains ownership and
assumes the loss. Partners may contribute
more capital to sustain the venture.
3. Loss of Use/Enjoyment Contribution – If
only the use of a thing is contributed and it is
lost, the partnership dissolves, and the
contributing partner bears the loss.

A partner’s failure to contribute capital does

not prevent the partnership’s existence but
may be waived by other partners.
Death of a Partner Civil Interdiction of a Partner
The death of a partner dissolves the partnership, and
the deceased partner ceases to be associated with the A partner under civil interdiction loses
business. the capacity to act and manage
Surviving partners can only continue operations for
winding up.
property, making their consent invalid.
A partnership agreement may allow business This incapacity can lead to the
continuity despite a partner’s death.
The deceased’s estate is only liable for obligations dissolution of the partnership as they
up to their capital or interest left in the business. can no longer fulfill their obligations.
Insolvency of a Partner or the Partnership The court may also decree dissolution
1. Insolvency of a Partner – The partner’s interest is for reasons like insanity, incapacity,
subject to creditors’ claims, and they lose authority to
act for the partnership. They also cannot fulfill misconduct, breaches, or if continuing
partnership obligations if assets are exhausted. the business becomes impractical or
2. Insolvency of the Partnership – The partnership’s unprofitable.
property is used to satisfy debts, making it unable to
continue operations, leading to dissolution.
Grounds for Dissolution by Court Decree
Effect of Dissolution on Partner’s
Authority
A court may dissolve a partnership upon application 1. General Rule – A partner’s authority
by: ends upon dissolution, except for winding
1. On Application by a Partner: up or completing unfinished transactions.
Insanity – Partner is judicially declared insane or No new business can be undertaken.
proven of unsound mind.
Incapacity – Partner is unable to perform partnership
2. Exceptions:
duties. If dissolution is not due to a partner’s act,
Misconduct/Breach – Prejudicial actions (e.g., insolvency, or death, authority terminates
persistent breach, misconduct). immediately.
Unprofitability – Business can only operate at a loss.
Other Equitable Grounds – Abandonment, fraud, If dissolution is due to a partner’s act,
refusal to account, etc. insolvency, or death, authority ends only
2. A Purchaser of a Partner’s Interest: when the acting partner is aware of the
If a partner’s interest is sold, the buyer may seek
dissolution.
dissolution after the agreed term ends or if the Third parties may still bind the partnership,
partnership is at will. but innocent partners can recover losses
Dissolution ends a partner’s authority, except for winding from the acting partner.
up or completing unfinished transactions
Right of a Partner to Contribution from Co- When a Partner Has Knowledge or
Partners Notice of a Fact
After dissolution, if a partner enters a new Knowledge – A partner has actual
contract, all partners remain liable unless the knowledge or enough facts to imply bad faith.
acting partner knew of the dissolution.
Notice – A partner is informed directly or
Each partner can demand contribution from co-
through written communication.
partners for any shared liability.
Effects:
Authority of Partners Among Themselves
If a partner knows of dissolution but still
A partner’s authority over co-partners ends only if: enters a contract, they assume full liability.
1. Dissolution is due to a partner’s act, and the
acting partner knew about it. If a partner only has notice, all partners may
2. Dissolution is due to death or insolvency, and the still share liability.
acting partner had notice. If dissolution is due to death or insolvency,
knowledge or notice prevents liability for other
These rules prevent unfair liabilities and protect
unaware partners.
partners.
Power of a Partner to Bind a Dissolved
Notice of Dissolution to Creditors
Partnership to Third Persons
For Existing Creditors: Those who extended
After dissolution, a partner cannot bind the credit before dissolution must receive
partnership, except for: actual notice to relieve the partnership from
1. Winding up business affairs. liability.
2. Completing unfinished transactions. For the Public: If they only knew of the
partnership’s existence (but did not extend
Third-Party Protection: If a third party had prior credit), a newspaper announcement is
sufficient.
dealings with the partnership and was not
informed of the dissolution, the partnership Insolvency Cases:
may still be liable for new contracts. An innocent partner unaware of another’s
insolvency can still bind the partnership.
Example: If a partner retires but no notice is A third party contracting with an insolvent
given, the partnership remains liable for partner is not protected and must verify the
transactions with unaware third parties. partner’s financial status.
Character of Notice Required Dormant Partner & Notice of
Dissolution
• For Prior Dealers (Creditors): Must receive A dormant partner (one who is unknown
actual notice of dissolution. Simply mailing a or inactive in the partnership) does not need
letter is insufficient if not received. Prior dealers to give notice of dissolution. Their liability is
are those who extended credit based on trust in limited to partnership assets unless
the partnership. otherwise agreed.
• For the Public (Non-Creditors): A newspaper
announcement is enough. No personal notice is Existing Liabilities: Dissolution does not
required. If someone was unaware of the automatically discharge a partner from prior
partnership before dissolution, no notice is obligations. A partner is only released if an
needed. agreement is made between them, the
creditor, and the continuing partners.
Example: If a buyer who only made cash Deceased Partner: Their personal assets
purchases (not a prior dealer) extends credit to remain liable for partnership debts incurred
the dissolved partnership after seeing a during their lifetime, but their separate
newspaper notice, they cannot hold the debts take priority.
partnership liable.
Effect of Dissolution on a Partner’s Existing
Liability of the Estate of a Deceased
Partner
Liability
Dissolution does not discharge a partner from
existing liabilities (Testate Estate of Mora vs. Serra, 47 The individual property of a deceased partner
Phil. 464). is liable for all partnership obligations incurred
A partner can only be relieved from liability through while they were a partner.
an agreement between them, the partnership creditor,
and the other partners. However, personal creditors of the deceased
Implied consent from the creditor and partners partner have priority over partnership
(through their conduct) may also indicate a release creditors regarding the separate assets of the
deceased.
from liability.
Example:
Manner of Winding Up a Dissolved If A, B, and C are partners and A dies, his
Partnership estate remains liable for partnership debts but
Winding up can be done in two ways: subject to the claims of his personal creditors
1. Judicially – Under the control and direction of the first.
court, upon request by a partner, legal representative,
or assignee.
Even if B and C agree to assume the debts, A’s
estate is not released unless creditors
2. Extrajudicially – Managed by the partners
expressly or implicitly agree (novation).
themselves without court intervention.
 Right of Partner to Application of Partnership
Persons Authorized to Wind Up the Property on Dissolution
Partnership The right of partners to have the partnership property used to
settle liabilities and distribute any surplus depends on whether
the dissolution:
The following individuals may wind up the
partnership affairs: 1. Complies with the partnership agreement (rightful
dissolution).
1. Partners designated by agreement.
2. Violates the partnership agreement (wrongful dissolution).
2. All partners who have not wrongfully dissolved
the partnership (if no agreement exists). Rights When Dissolution not in contravention
3. The legal representative of the last surviving Unless otherwise agreed, each partner has the right to:
partner, if all partners are deceased and the 1. Have the partnership property applied to pay off partnership
representative is not insolvent. debts.
2. Receive their share of the surplus in cash.
Key Points: If a partner is expelled in good faith (without breaching the
The surviving partners (not the legal agreement), they:
representative of a deceased partner) are May be released from liability if creditors, the remaining
partners, and the expelled partner agree.
responsible for winding up the business.
Are entitled only to receive their net share in cash.
The estate of a deceased partner is not liable for
debts or losses incurred by surviving partners if they In a rightful dissolution, no partner is liable for losses resulting
from the dissolution.
continue the business without the estate’s consent.
 Right of a Partner to Rescind the Partnership Contract
Rights When Dissolution Violates the Agreement
A partnership contract can be annulled if a partner was
1. Rights of the Innocent Partner: induced by fraud or misrepresentation (Art. 1390[2]).
Have partnership property used to pay debts and receive
their share of the surplus. The injured partner is entitled to restitution upon
Be indemnified for damages caused by the guilty partner. annulment (Art. 1398).
Continue the business under the same name and possess
partnership property. Fraud or misrepresentation invalidates consent
Until annulled, the partnership remains liable for
2. Rights of the Guilty Partner: obligations to third parties.
If the business is NOT continued: Receive their share of the
surplus minus damages for wrongful dissolution.
If the business is continued:
Get the value of their interest in cash or secured by bond. Rights of an Injured Partner When a Partnership
Be released from partnership liabilities, but goodwill is Contract is Annulled (Rescinded)
excluded in valuation. 1. Right of Lien/Retention – The injured partner can retain the
surplus of partnership property after liabilities are settled.
Rescission Due to Fraud or Misrepresentation:
Right to a lien on surplus assets after debts are paid. 2. Right to Subrogation – After paying partnership liabilities, the
Stand in place of creditors for payments made on behalf of injured partner steps into the creditors’ place.
the partnership. 3. Right to Indemnification – The guilty partner must indemnify
Be indemnified by the guilty partner for all debts and the injured partner for all partnership debts and liabilities.
liabilities.
Right of a Partner to Rescind a Partnership Settlement of Accounts After Dissolution
Contract
1. Assets include: partnership property and
A partnership contract is voidable if induced by partner contributions.
fraud or misrepresentation (Art. 1390[2]). The 2. Liabilities are paid in order:
injured partner may seek annulment and is Creditors (non-partners)
entitled to restitution (Art. 1398). However, until Partner capital contributions
annulled, the partnership remains liable to third Partners (excluding capital & profits)
parties. Partner profits
3. Partners contribute to cover liabilities.
Rights of an Injured Partner When the 4. Creditors have priority over partnership
Partnership is Rescinded property, and separate creditors over
1. Right to a lien on surplus partnership property individual assets.
after liabilities are paid. 5. Insolvent partner’s estate pays separate
2. Right to subrogation in place of partnership creditors first, then partnership creditors,
creditors after liabilities are settled. then partners.
3. Right to indemnification from the guilty partner
for all debts and liabilities.
Liquidation & Distribution of Assets 4. Deceased Partner’s Liability
Winding up: Converting partnership assets into cash. Their estate covers liabilities incurred while they
Distribution: Proceeds are allocated to creditors and
were a partner.
partners.
Authority: Partners can sell assets and settle 5. Creditor Priority
obligations.
Liquidating Partner: Handles the process if designated. Partnership creditors are paid first from
partnership assets.
Settlement of Accounts After Dissolution
1. Assets of the Partnership
Separate creditors are paid from individual
Partnership property (including goodwill). partner assets.
Contributions from partners to cover liabilities. 6. Insolvent Partner’s Property Distribution
2. Order of Payment
1st: Partnership creditors. 1st: Separate creditors.
2nd: Loans/advances by partners.
3rd: Return of capital contributions. 2nd: Partnership creditors.
4th: Distribution of remaining profits.
3rd: Other partners (contributions).
3. Insufficient Assets
Partners must contribute to cover losses.
Non-paying partners can be sued for indemnification.
Dissolution by Change in Membership Liability of Persons Continuing the
A partnership dissolves when there is a change in partner Business of a Dissolved Partnership
relations.
Occurs when a partner is admitted, retires, dies, withdraws, • New or incoming partners are only liable
or is expelled. for partnership debts through partnership
Dissolution also happens when:
A sole remaining partner takes over.
assets, unless agreed otherwise.
All partners transfer their rights to third parties.
Any change in membership ends the existing partnership and
• If a third party buys the business and
creates a new one. agrees to pay debts, creditors of the
dissolved partnership can also claim from
Rights of Creditors of a Dissolved Partnership That the new owner.
Continues
If a partnership dissolves due to a change in membership but • A retired or deceased partner (or their
continues operating without liquidation, old creditors remain
creditors of the new partnership.
estate) is entitled to the value of their
Both old and new creditors have equal rights over interest at dissolution, either as a creditor
partnership assets. with interest or a share in the profits.
New partners are not personally liable for the debts of the old
firm, but their investment is part of the firm’s assets and is • Old creditors have priority over separate
available to all creditors. creditors of the retired or deceased partner.
This ensures fair treatment for all creditors, regardless of
changes in ownership.
Rights of a Retiring or Deceased Partner’s Right to Account of
Partner’s Legal Representative Interest
A partner or their legal representative
The retiring or deceased partner’s interest
must be valued as of the date of
can demand an accounting of their
dissolution. interest after dissolution unless agreed
They have the right to receive either the otherwise.
value of their share with interest or a share This right applies against the
of the profits from its use. winding-up partner, surviving partner,
Creditors of the dissolved partnership
or new partnership continuing the
have priority over the claims of the retired or
deceased partner.
business.
If the business continues without the Liquidation is not required if there is
estate’s consent, the estate has no liability. a prior settlement or agreement on the
If it consents, it becomes a new partner, amount to be received.
liable only up to the deceased’s share.
PREPARED BY:

Arsad Moneb
Terenz Abila