WHAT HAPPENS IF A PARTNER BECOMES INSOLVENT? In 2001, three dentists—Ben Rogers,
ID: 2454235 • Letter: W
Question
WHAT HAPPENS IF A PARTNER BECOMES INSOLVENT? In 2001, three dentists—Ben Rogers, Judy Wilkinson, and Henry Walker—formed a part- nership 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, con- structed 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 antici- pate 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 2013 he was spending less time with the dental practice so that he could concentrate on his in- vestments. Unfortunately, a number of these deals proved to be bad decisions and he incurred significant losses. On November 8, 2013, while Rogers was out of town, his personal creditors filed a $97,000 claim against the partnership assets. Unbeknownst to 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?
Explanation / Answer
Answer:
Alternatives available to Wilkinson and Walker:-
1. Take loan on building and other properties:
a. Advantages:
(i) Will solve liquidity problem to meet creditors claim.
(ii) Wilkinson and Walker can carry on their practice.
(iii) Will be able to save partnership from dissolving.
b. Disadvantages:
(i) Will have to bear interest cost on loan.
(ii) There was already a Bank- loan. Further loan will not be easy.
(iii) Excess loan is not good for any business.
2. Issue Note Payable to creditors after convincing him:
a. Advantages:
(i) Creditors need not be paid immediately. They can be paid once profit is generated by Wilkinson and Walker.
(ii) No need to approach any bank or any other person to meet liquidity problem.
(iii) Wilkinson and Walker can carry on their practice.
b. Disadvantages:
(i) Will have to bear interest cost on note payable.
(ii) Convincing creditors about note payable will not be easy for their claims.
(iii) Creditors may demand high rate of interest as compared to other banks and financial institution.
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