When a partner to a business withdraws, this results in the dissolution of the partnership. The legal relations between the partners terminate.
But what happens to the partnership business, if a partner withdraws?
Legal Effects of Partnership Dissolution After a Partner Withdraws
The dissolution of a partnership under the Civil Code is the change in the relation of the partners caused by any partner ceasing to be associated in the carrying on, as distinguished from the winding up, of the business.[1] Hence, Art. 1829 of the Civil Code states that “on dissolution, the partnership is not termination but continues until the winding up of partnership affairs is completed.”
In the case of Testate Estate of Lazaro Mota vs. Salvador Serra[2], the Supreme Court held that:
“The dissolution of a partnership must not be understood in the absolute and strict sense so that at the termination of the object for which it was created the partnership is extinguished, pending the winding up of some incidents and obligations of the partnership, but in such case, the partnership will be reputed as existing until the juridical relations arising out of the contract are dissolved.” [Emphasis and underscoring supplied.]
In the same case of Mota[3], the Supreme Court went on to say that:
“The dissolution of a firm does not relieve any of its members from liability for existing obligations, although it does save them from new obligations to which they have not expressly or impliedly assented, and any of them may be discharged from old obligations by novation of other form of release. It is often said that a partnership continues, even after dissolution, for the purpose of winding up its affairs.”
Clearly, the dissolution of a partnership does not mean its termination. In the case of Jesus Sy vs. Court of Appeals[4], the Supreme Court elucidated that upon such dissolution, the legal personality of the partnership continues, thus:
“Petitioners fail to recognize the basic distinctions underlying the principles of dissolution, winding up and partition or distribution. The dissolution of a partnership is the change in the relation of the parties caused by any partner ceasing to be associated in the carrying on, as might be distinguished from the winding up, of its business. Upon its dissolution, the partnership continues, and its legal personality is retained until the complete winding up of its business culminating in its termination.
The dissolution of the partnership did not mean that the juridical entity was immediately terminated and that the distribution of the assets to its partners should perfunctorily follow. On the contrary, the dissolution simply effected a change in the relationship among the partners. The partnership, although dissolved, continues to exist until its termination, at which time the winding up of its affairs should have been completed and the net partnership assets are partitioned and distributed to the partners.” [Emphasis and underscoring supplied.]
Partnership Not Automatically Terminated Upon Dissolution
The case of Primelink Properties and Development Corporation vs. Ma. Clarita Lazatin-Magat[5] is likewise instructive, wherein the Supreme Court held that on dissolution, the partnership is not automatically terminated:
On the second issue, we agree with the CA ruling that petitioner Primelink and respondents entered into a joint venture as evidenced by their JVA which, under the Court’s ruling in Aurbach, is a form of partnership, and as such is to be governed by the laws on partnership.
When the RTC rescinded the JVA on complaint of respondents based on the evidence on record that petitioners willfully and persistently committed a breach of the JVA, the court thereby dissolved/cancelled the partnership. With the rescission of the JVA on account of petitioners’ fraudulent acts, all authority of any partner to act for the partnership is terminated except so far as may be necessary to wind up the partnership affairs or to complete transactions begun but not yet finished. On dissolution, the partnership is not terminated but continues until the winding up of partnership affairs is completed. Winding up means the administration of the assets of the partnership for the purpose of terminating the business and discharging the obligations of the partnership.
The transfer of the possession of the parcels of land and the improvements thereon to respondents was only for a specific purpose: the winding up of partnership affairs, and the partition and distribution of the net partnership assets as provided by law. After all, Article 1836 of the New Civil Code provides that unless otherwise agreed by the parties in their JVA, respondents have the right to wind up the partnership affairs:
Art. 1836. Unless otherwise agreed, the partners who have not wrongfully dissolved the partnership or the legal representative of the last surviving partner, not insolvent, has the right to wind up the partnership affairs, provided, however, that any partner, his legal representative or his assignee, upon cause shown, may obtain winding up by the court.
It must be stressed, too, that although respondents acquired possession of the lands and the improvements thereon, the said lands and improvements remained partnership property, subject to the rights and obligations of the parties, inter se, of the creditors and of third parties under Articles 1837 and 1838 of the New Civil Code, and subject to the outcome of the settlement of the accounts between the parties as provided in Article 1839 of the New Civil Code, absent any agreement of the parties in their JVA to the contrary. Until the partnership accounts are determined, it cannot be ascertained how much any of the parties is entitled to, if at all.
At this juncture, it is well to note that Art. 1832 of the Civil Code provides the direct effect of the dissolution of partnership, to wit:
“Art. 1832. Except so far as may be necessary to wind up partnership affairs or to complete transactions begun but not then finished, dissolution terminates all authority of any partner to act for the partnership:
(1) With respect to the partners:
(a) When the dissolution is not by the act, insolvency or death of a partner; or
(b) When the dissolution is by such act, insolvency or death of a partner, in cases where article 1833 so requires;
(2) With respect to persons not partners, as declared in article 1834.” [Emphasis supplied.]
Villanueva, a distinguished author in the field of Agency, Trust, and Partnership, opined that such dissolution focuses on the breaking-up of the contractual relationship or privity of the partners among one another.[6]
Legal Personality of a Partnership Continues After Dissolution
Hence, as stated under Art. 1832, dissolution extinguishes the right and power of the partners to represent one another to pursue the partnership, “except so far as may be necessary to wind up partnership affairs or to complete transactions begun but not then finished.”[7]
Dissolution of a partnership should, perforce, NOT undermine existing contracts, nor modify or extinguish then existing obligations of the partnership and the partners. In fact, the completion or performance of existing contracts and the settlement of partnership obligations are integral parts in the winding-up process.[8]
Accordingly, once a partnership business is dissolved with due to the withdrawal of a partner, its legal personality will remain until the completion of its existing contracts, and the performance of its obligations to third parties.
Villanueva opined that although not explicitly stated in the provisions of the Civil Code, the partnership may constitute also a “business enterprise” or what is known in the disciplines of Economics and Accounting as a “going concern”.[9]
Notably, our Civil Code allows the partnership to continue to wind up its affairs or to complete transactions begun but not then finished[10]. This means that the dissolution of an existing partnership contract may actually lead to the constitution of a new partnership contract among the parties who choose to proceed with the partnership business.[11]
Dissolution of a Partnership does Not End the Partnership Business
It is axiomatic that dissolution refers to the change in partnership relation, and NOT the actual cessation of the partnership business.[12]
In fact, Art. 1840 of the Civil Code recognizes that a partnership may be dissolved, but the underlying partnership business enterprise would not be wound-up and may be continued as a going concern by the remaining partners, alone or with new partners.[13]
Art. 1840 states that if the dissolved partnership is not wounded-up and the parties so qualified have chosen to continue the business of the partnership, then the creditors of the dissolved partnership shall also be creditors of the person or partnership continuing the business[14], thus:
“(1) When any new partner is admitted into an existing partnership, or when any partner retires and assigns (or the representative of the deceased partner assigns) his rights in partnership property to two or more of the partners, or to one or more of the partners and one or more third persons, if the business is continued without liquidation of the partnership affairs;
(2) When all but one partner retire and assign (or the representative of a deceased partner assigns) their rights in partnership property to the remaining partner, who continues the business without liquidation of partnership affairs, either alone or with others;
(3) When any partner retires or dies and the business of the dissolved partnership is continued as set forth in Nos. 1 and 2 of this article, with the consent of the retired partners or the representative of the deceased partner, but without any assignment of his right in partnership property;
(4) When all the partners or their representatives assign their rights in partnership property to one or more third persons who promise to pay the debts and who continue the business of the dissolved partnership;
(5) When any partner wrongfully causes a dissolution and the remaining partners continue the business under the provisions of article 1837, second paragraph, No. 2, either alone or with others, and without liquidation of the partnership affairs;
(6) When a partner is expelled and the remaining partners continue the business either alone or with others without liquidation of the partnership affairs.” [Emphasis supplied.]
Dissolved Partnership is Still Liable to Creditors
The rules of liability under Art. 1840 should be construed in consonance with the doctrine and overarching public consideration of protecting creditors who deal in good faith with the partnership business and who cannot be expected to be aware of the inner workings of the partnership and the intramural dealings of the partners.[15]
Of note is the case of Singson vs. Isabella Sawmill[16], where the Supreme Court held a withdrawing partner liable to a third-party creditor of the old partnership. Interestingly, the withdrawing partner failed to publish her withdrawal from the partnership and agreed to have the remaining partners proceed with running the partnership business instead of insisting on the liquidation of the partnership. The Supreme Court ruled, to wit:
“Although it may be presumed that Margarita G. Saldajeno had action in good faith, the appellees also acted in good faith in extending credit to the partnership. Where one of two innocent persons must suffer, that person who gave occasion for the damages to be caused must bear the consequences. Had Margarita G. Saldajeno not entered into the memorandum-agreement allowing Leon Garibay and Timoteo Tubungbanua to continue doing the business of the partnership, the appellees would not have been misled into thinking that they were still dealing with the partnership “Isabela Sawmill”. Under the facts, it is of no moment that technically speaking the partnership “Isabela Sawmill” was dissolved by the withdrawal therefrom of Margarita G. Saldajeno. The partnership was not terminated and it continued doing business through the two remaining partners.” [Emphasis and underscoring supplied.]
It is also well to note the case of Petition for Authority to Continue Use of the Firm Name “Sycip, Salazar, etc.”/ “Ozaeta, Romulo, etc.”, where the Supreme Court pronounced that Art. 1840 of the Civil Code deals more with a commercial partnership with a good to will to protect, rather than of a professional partnership, to wit:
Secondly, Article 1840 treats more of a commercial partnership with a good will to protect rather than of a professional partnership, with no saleable good will but whose reputation depends on the personal qualifications of its individual members. Thus, it has been held that a saleable goodwill can exist only in a commercial partnership and cannot arise in a professional partnership consisting of lawyers.
As a general rule, upon the dissolution of a commercial partnership the succeeding partners or parties have the right to carry on the business under the old name, in the absence of a stipulation forbidding it, (s)ince the name of a commercial partnership is a partnership asset inseparable from the good will of the firm. … (60 Am Jur 2d, s 204, p. 115) x x x” [Emphasis supplied.]
It is thus clear that a business enterprise of a commercial partnership or partnership business may continue notwithstanding the dissolution of such partnership due to changes in the membership, or withdrawal of a partner.
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[1] Art. 1828, Civil Code.
[2] G.R. No. L-22825, 14 February 1925.
[3] Ibid.
[4] G.R. No. 94285, 31 August 1999.
[5] G.R. No. 167379, 27 June 2006.
[6] pp. 664-665; p. 686, Villanueva (Supra, Note 13).
[7] Art. 1832, Civil Code.
[8] p.686
[9] p. 465, Villanueva (Supra, Note 13).
[10] Art. 1832, Civil Code.
[11] Art. 1837 (2), 1840, 1841, Civil Code; p. 270, De Leon & De Leon, Jr. (Supra, Note 8); p. 686, Villanueva (Supra, Note 13).
[12] Art. 1828, 1837, and 1840, Civil Code; p. 219, De Leon & De Leon, Jr. (Supra, Note 8).
[13] Art. 1840, Civil Code; p. 707, Villanueva (Supra, Note 13); p. 271, De Leon & De Leon, Jr. (Supra, Note 8).
[14] p. 708, Villanueva (Supra, Note 13).
[15] p. 710, Villanueva (Supra, Note 13).
[16] Supra, Note 10.
