Financial Resolutions of Partnership Disputes-Introduction

Financial Resolutions of Partnership Disputes-Introduction
January 2, 2014 Serena Morones
partnership dispute

Article 1:  Introduction to financial resolution in partnership disputes

By Serena Morones, CPA, ASA, ABV, CFE

With Attorney Ben Stoller of Slinde Nelson Stanford

partnership disputeWe present this series of articles to help professional advisors determine a fair financial resolution in a partnership dispute.  I (Serena Morones) have served as an accounting and valuation expert in several financially confusing partnership disputes.  The confusion about financial issues can cause the resolution process to bloat with professional fees and frustrate the clients.

The client hopes to walk away from a business partnership with their share of the money.  However, identifying a particular partner’s share of the partnership value can be an elusive and expensive process caused by the peculiarities of partnership law, accounting and valuation.

I’ve found that attorneys do a great job of emphasizing the law, but often lack the expertise to untangle the financial relationships of a partnership. I have also observed that many Certified Public Accountants don’t understand the unique aspects of partnership law that drive a financial resolution.  Also, many business appraisers assigned to appraise a partnership don’t understand the relevance of partnership capital accounts to the allocation of business value to a particular partner.  When professional providers come together with only their partial expertise, the dispute can remain mired in obscurity unless someone assembles the whole financial puzzle.

This series of articles will address unique financial aspects of separating a partner from a partnership, or complete partnership dissolution.  I hope that through these articles, attorneys, CPAs and business appraisers will see a more complete framework for reaching a financial resolution in a partnership dispute.  I will also address draw comparisons to limited liability companies (LLCs).  However, I have found that LLCs tend to be more organized, due to the heightened requirement of formality upon formation.

Partnership disputes are difficult to unwind

Why can a partnership relationship be more difficult to unwind than a corporate shareholder relationship?  Three reasons:  first, partnerships are more easily and casually created (even accidentally created), reducing the clarity of the agreed profit and equity sharing ratios and therefore clouding the means to ultimate division of value.  Second, since partnerships can be casually or accidentally formed, partners may casually account for the business relationship and thereby create a financial mess that must be cleaned up by expensive professionals, further obscuring financial separation.  And third, partnerships possess unique legal and accounting concepts, including aspects of an aggregate theory of business ownership. These unique legal and accounting concepts are not always understood by the partners and their business advisors because partnership as a form of ownership has become less common in recent years.

An aggregate theory of business ownership means that each partner is viewed as a separate business unit, operating alongside other partners for the purpose of mutually enhancing the overall business.  This aggregate theory means that each partner’s business activities must be separately accounted for through use of capital accounts, in order to understand each partner’s relative share of the whole.

Some background on partnership law will be foundational to these articles.  The National Conference of Commissioners of Uniform State Law (NCCUSL), made up of attorneys, judges, and law professors, prepares legislation (model statutes) to be incorporated by states into their state legislation.  The Uniform Partnership Act (UPA) is one such uniform law. Originally created in 1914, the UPA was adopted by every state except Louisiana.  Each state statute was based upon the UPA but may have had some differences and variations from the UPA.  However, each state statute was substantially as proposed by the UPA.

In 1994 the NCCUSL published the Revised Uniform Partnership Act (RUPA), which was then revised in 1997.   A majority of states (37) adopted  RUPA, while 12 retained UPA, and Louisiana has still not adopted either UPA or RUPA.

Differences in RUPA and UPA

There are a number of differences between RUPA and UPA, one being that RUPA largely assumes an entity theory rather than an aggregate theory, such as for identification of asset ownership. For example, the partnership entity is assumed to own partnership assets, as opposed to the individual partners.  But in other areas that relate to dispute resolution, such as determination of a partner’s share of capital ownership and allocation of assets upon dissolution, RUPA still reflects aspects of an aggregate theory.[1]

Lawyers generally don’t rely on RUPA or UPA because each state has incorporated variations from the model acts and attorneys must be careful to precisely apply the law of each state.

Of course, a partnership agreement or dispute settlement agreement can override the provisions of state law with some limitations.  However, because many disputes are caused by an absence of a clearly documented agreement, the financial affairs of the partnership must be unwound by application of sound legal, accounting and valuation theory, specifically applicable to partnerships.

The following chart graphically depicts some of the topics I plan to address in this series of articles.  The chart depicts the value of hypothetical professional services partnership that is named and led by one professional with strong client relationships.  There are many business models of partnerships that I may discuss.  However, I’ve found that professional service partnerships with a high degree of personal goodwill commonly result in a separation dispute and provide several topics illustrative of the unique issues involved in separating partners.

Business Value and Accounting

The key topics I plan to discuss are divided into two primary areas:  Business Value (including allocation of value to a particular partner’s interest) and Accounting.  As this series of articles develops, I may add additional topic areas.  I will start the series with the topic of Accounting, because in my opinion, it is not feasible to determine entity value or allocate value to the partners, unless the accounting for the partnership is accurate and complete.  This complete accounting will include determination of partner capital accounts, identification of personal expenses run through the business (a common source of partner disputes), as well as proper accounting for other common partnership transactions such as partner compensation and services provided in exchange for partnership interests.

financial resolution, partnership disputes

I sincerely hope that these articles improve the clarity of the process at arriving at a reasonable dollar amount that a partner should receive upon the conclusion of a partnership relationship.  Please email me at [email protected] with any feedback or suggestions for topic areas that you think I should cover in this series.

 

Serena Morones, CPA, ASA, ABV, CFE

With attorney Ben Stoller of Slinde Nelson Stanford

www.slindenelson.com

 

Read Article Two:  Partnership Accounting with Capital Accounts

 


[1] The Revised Uniform Partnership Act (RUPA) Section 401 sets out the rules for calculating capital accounts.  RUPA section 807 sets out the rules regarding the settlement of the partners’ accounts upon the dissolution and windup.  These rules requiring a separate accounting for each partner, reflect an aggregate theory of ownership.

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