Withdrawing From a Partnership

The withdrawal of a partner from a business is a commonly overlooked issue, yet one which everyone should think through when they first decide to go into business together. Failing to address this critical issue at the outset can result in unnecessary conflict and even costly litigation later.

Why Do Partners Leave a Partnership?

A partner might leave (or "dissociate" from) a partnership voluntarily or involuntarily. When a partner exits the business, the partnership can either continue or dissolve (end), depending on what the partnership agreement or state law allows or requires.

When a Partner Voluntarily Withdraws

Business partners can decide to leave a business for many reasons:

• they might not be committed to the business
• the business might not be as successful as they envisioned
• they might discover a new venture they would like to pursue instead; or
• they might decide they want to retire.

When a Partner Involuntarily Withdraws

Alternatively, a partner could be forced to exit the partnership. A partner might leave a partnership involuntarily when:

• they're expelled (or forced out) by the other partners—usually when they breach the partnership agreement or engage in wrongful conduct that hurts the business
• they die or become incapacitated
• they file for bankruptcy, or
• a court orders their expulsion.

As part of deciding to go into business together, partners should decide what'll happen if one of them leaves the partnership—whether voluntarily or involuntarily. The partners should make sure that whatever they decide on is accurately reflected either in the buyout provisions of their partnership agreement or in a separate partnership buyout agreement. Putting these terms into writing will help ensure a smooth and orderly transition for the partners when one is ready or forced to exit the partnership.

What Rules Must a Partnership Follow When A Partner Leaves?

If you and one or more other people own and run a business together and you haven't formed a corporation or limited liability company, then you have a general partnership. While not required, most business partners enter into written agreements that spell out the parties' rights and responsibilities, including what happens if one person wants to leave the business.

One of the noteworthy characteristics of general partnership law is the extent to which the partners can establish their own rules for how the partnership operates. Except in certain circumstances, partners can agree to partnership terms that are different from those provided under state law. In general, state law is used to fill in gaps or serve as default rules where partnership agreements either don't exist or are silent.

Check Your Partnership Agreement

Most partnership agreements include provisions—called "buyout provisions"—that cover the basic issues that arise when one partner decides to withdraw. Instead of including these terms as provisions within a partnership agreement, some partnerships address these issues in separate partnership buyout agreements.

These provisions or agreements should answer questions such as:

• Do the remaining partner or partners have a right of first refusal to buy the partnership interest?
• How will the purchase price for the partnership interest be determined?
• What if there are no buyers for the partnership interest?
• What happens to the business when the partner leaves?

If you have a partnership agreement that includes provisions about partner withdrawal, then those are the rules you should look to when a partner decides to leave the partnership. To the extent an issue isn't addressed in your agreement, your state's partnership laws will apply.

Look at Your State Partnership Laws

The modern sources of general partnership law are the Uniform Partnership Act (UPA) and the Revised Uniform Partnership Act (RUPA). Every state except for Louisiana has adopted either the UPA or the RUPA with approximately 41 states adopting the RUPA (or a variation of it).

Under both the UPA and RUPA, a partner has the right to withdraw from the partnership at any time, as long as proper notice (if required) is given. However, the UPA and RUPA have different rules about what happens to the partnership itself when a partner withdraws.

Partnership withdrawal rules under the UPA. Under the UPA, the withdrawal of a partner from the partnership automatically causes a dissolution of the partnership.

Partnership withdrawal rules under the RUPA. One of the major reforms introduced with RUPA was to allow a partner to withdraw without automatically causing a dissolution of the partnership. In most cases, under RUPA, a partnership can buy out the interest of a partner without ending the business. In addition, a partnership set up for a specific term won't dissolve as long as at least one-half of the partners choose to remain.

What Happens When a Partner Withdraws?

Your partnership agreement or state law will determine what happens when a partner withdraws. In either case, the remaining partners and withdrawing partner have rights and obligations.

Providing Notice of a Partner's Withdrawal

If a partner decides to voluntarily withdraw from the partnership, they'll need to provide notice to the other partners. Your partnership agreement might provide additional restrictions. For instance, your agreement might require the notice be in writing and be given a certain number of days (for instance, 90 days) before the withdrawal takes effect.

When a partner involuntarily withdraws from a partnership, notice isn't usually required because the partner isn't making the choice to leave the business.

Buying Out the Withdrawing Partner's Share in the Business

When a partner leaves and the business continues, the departing partner still has a share in the partnership. Unless the partner transfers their interest, the partnership will usually need to continue making distributions to the former partner. (For answers to specific question about buying a partner's interest, see our article on buy-sell agreement FAQ.)

There are a few options for a departing partner's interest in the business:

• The partnership can buy their interest.
• One of the partners can buy their interest.
• Someone outside of the partnership can buy their interest.

The partners will most likely prefer for the partnership or an existing partner to buy the other partner's interest rather than risk someone outside of the partnership buying into the business. If the partners want to make specific rules for how a partner can be bought out, they should document these rules in the buyout provisions of their partnership agreement or in their partnership buyout agreement.

If the partners want to buy out the departing partner's interest, then it's a good idea to predetermine a price for the share. The partners can either decide on a price for each partner's share beforehand or they can decide on a way to calculate a price for each partner's share. Usually, the price for a partner's share is determined by:

• the business's current value (if liquidated)
• the business's equity (or "book") value—that is, its value after subtracting its liabilities from its assets, or
• the present value of a future flow of distributions.

In a case where a partner has died, the partner's estate or heir will be compensated for the deceased partner's share.

Dissolving the Partnership

Sometimes the partnership agreement or state law will require the partnership to dissolve when one partner leaves the business. The fate of the partnership might depend on how the partner left—whether voluntarily or involuntarily. For example, your partnership agreement might say that the business can continue if a partner retires but the partnership must dissolve if a partner dies.

If a partner's departure triggers an end to the partnership, the partners will need to follow a dissolution procedure. In this case, the partnership will settle its debts and distribute any remaining assets to the partners—including the withdrawing partner—according to their capital accounts.

Consulting a Business Attorney

When a partner leaves, your business can be turned upside down. If you have a partnership agreement with a specific procedure for partner withdrawal, you can probably navigate the process yourself. But if you don't have a written agreement or the terms in the buyout provisions are ambiguous, it can be a good idea to talk to a business lawyer. They can help you negotiate and draft a partnership buyout agreement and assess your rights in and obligations to the partnership.