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Hope for the best, but prepare for the worst. It’s a credo that has sustained business partnerships through good times and bad. But for some reason, many business partners don’t prepare for the absolute worst: the withdrawal or death of a business partner.
I was recently involved in a case involving a two-person law firm that had a reputable transactional attorney draft their partnership agreement. One provision specifically referred to what would occur if a partner were to voluntarily withdraw, become disabled or die. Under this provision, the partners agreed to allow the firm’s accountant to perform a valuation of the departing/deceased partner’s interest utilizing specific criteria. A second provision addressed dissolution (an event that would not allow partnership to continue). Under this provision, the affairs of the partnership would be resolved in accordance with the Uniform Partnership Act, and each partner would receive 50 percent of the partnership assets.
Unfortunately, one of the partners passed away. While it was believed by the surviving partner that the provision related to withdrawal, death or disability should apply, the widow of the deceased partner was not happy with the accountant’s valuation and asserted that her husband’s death was actually a dissolution under the partnership agreement. More specifically, the widow argued that since at least two individuals are required to form a partnership, the death of her husband was de facto an event of dissolution, requiring the winding up of the affairs of the partnership and corresponding sale of all partnership assets.
It turns out she was correct.
This resulted in the surviving partner paying approximately $300,000 more than the value that had been calculated by the firm accountant under the “death or disability” provision of the partnership agreement, performing substantial work for free for his partner’s estate and incurring substantial legal fees in defending his position.
Too often, business people fail to ask the right questions when it comes to the withdrawal or death of a partner in their business. The above highlights the need to assure, ab initio, that when entrepreneurs form a new business, they carefully review and understand the partnership agreement, operating agreement or shareholder agreement that they adopt. Careful attention should be paid to address whether:
- The business will continue as an ongoing entity in the event of the death, disability or withdrawal of a partner, shareholder or member.
- How the partner, shareholder or member’s interest will be valued.
- Who will perform the valuation? This can be done by an agreed-upon individual, including a company accountant. You can also take the average of the valuation performed by an expert retained by each party to the transaction.
- Who will be responsible for winding up the affairs of the business in the event of the withdrawal, death or disability? Under the Uniform Partnership Act, the partner who performs this task is not entitled to additional compensation for his or her services. This issue may be addressed in the partnership, shareholder or operating agreement.