Discussion 7: What Happens If a Partner Becomes Insolvent?
In 2001, three dentists—Ben Rogers,
Judy Wilkinson, and Henry Walker—formed a partnership to open a practice in
Toledo, Ohio. The partnership’s primary purpose was to reduce expenses by
sharing building and equipment costs, supplies, and the services of a clerical
staff. Each contributed $70,000 in cash and, with the help of a bank loan,
constructed a building and acquired furniture, fixtures, and equipment. Because
the partners maintained their own separate clients, annual net income has been
allocated as follows: Each partner receives the specific amount of revenues
that he or she generated during the period less one-third of all expenses. From
the beginning, the partners did not anticipate expansion of the practice;
consequently, they could withdraw cash each year up to 90 percent of their
share of income for the period.
The partnership had been profitable
for a number of years. Over the years, Rogers has used much of his income to
speculate in real estate in the Toledo area. By 2015 he was spending less time
with the dental practice so that he could concentrate on his investments.
Unfortunately, a number of these deals proved to be bad decisions and he
incurred significant losses. On November 8, 2015, while Rogers was out of town,
his personal creditors filed a $97,000 claim against the partnership assets.
Wilkinson and Walker, Rogers had
become insolvent. Wilkinson and Walker hurriedly met to discuss the
problem because Rogers could not be located. Rogers’s capital account was
currently at $105,000, but the partnership had only $27,000 in cash and liquid
assets. The partners knew that Rogers’s equipment had been used for a number of
years and could be sold for relatively little. In contrast, the building had
appreciated in value, and the claim could be satisfied by selling the property.
However, this action would have a tremendously adverse impact on the dental
practices of the remaining two partners.
What alternatives are available to Wilkinson and Walker, and
what are the advantages and disadvantages of each?