8.

Liability of person or partnership continuing business to dissolved partnerships creditors

art. 1840, (1), (2), (3), (4), (5), (6)

Art. 1840. In the following cases creditors of the dissolved partnership are
also creditors of the person or partnership continuing the business:
(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.
The liability of a third person becoming a partner in the partnership
continuing the business, under this article, to the creditors of the
dissolved partnership shall be satisfied out of the partnership property
only, unless there is a stipulation to the contrary.
When the business of a partnership after dissolution is continued under
any conditions set forth in this article the creditors of the dissolved
partnership, as against the separate creditors of the retiring or deceased
partner or the representative of the deceased partner, have a prior right
to any claim of the retired partner or the representative of the deceased

partner against the person or partnership continuing the business, on

account of the retired or deceased partner's interest in the dissolved
partnership or on account of any consideration promised for such interest
or for his right in partnership property.
Nothing in this article shall be held to modify any right of creditors to set
aside any assignment on the ground of fraud.
The use by the person or partnership continuing the business of the
partnership name, or the name of a deceased partner as part thereof,
shall not of itself make the individual property of the deceased partner
liable for any debts contracted by such person or partnership. (n)

Dissolution of a partnership by change in membership.

(1) Causes. The change in the relation of the partners resulting in the dissolution
of the partnership may take place when a new partner is admitted; or when a
partner retires; or dies; or when a partner withdraws; or is expelled from the
partnership; or when the other partners assign their rights to the sole remaining
partner (Bernardo vs. Pascual, 109 Phil. 936 [1960].); or when all the partners
assign their rights in partnership property to third persons.
Any change in membership dissolves a partnership and creates a new one.
(2) Continuation of partnership without liquidation. A partnership dissolved by
any of these happenings need not undergo the procedure relating to dissolution and
winding of its business affairs. The remaining partners (and/or new partners) may
elect to continue the business of the old partnership without interruption by simply
taking over the business enterprise owned by the preceding partner and continuing
the use of the old name.10 The rights and obligations of the partners as among
themselves in case of such continuation are set forth in Article 1837.
As the partnership is the result of a contract, a change in the parties to the contract
necessarily results in a new contract. Hence, a change in membership of a
partnership creates a new partnership upon the continuation of the business by the
partners.
Rights of creditors of dissolved partnership which is continued.
Article 1840 deals with the rights of creditors when the partnership is dissolved by a
change of membership and its business is continued (Art. 1837[2].) by a former
partner, either alone or with new partners, without liquidation of partnership affairs.
(1) Equal rights of dissolved and new partnership creditors. In such case, the law
makes the creditors of the dissolved partnership also creditors of the persons or
partnership continuing the business. In other words, both classes of creditors, the
old and the new, are treated alike, being given equal rights in partnership property.
The purpose of the law is to maintain the preferential rights of the old creditors to
the partnership property as against the separate creditors of the partners. It is
immaterial to determine under which one or more of the six (6) cases mentioned in
Article 1840 the dissolution falls the creditors of the old partnership are also the
creditors of the new partnership which continues the business of the old one without

liquidation of the partnership affairs. (Yu vs. National Labor Relations Commission,
224 SCRA 75 [1993].)
(2) Liability of persons continuing business. Note that under paragraph 2, the
liability of the new or incoming partners shall be satisfied out of partnership
property only unless there is a stipulation to the contrary. (Art. 1826.) Note that
paragraph 1, No. 4, applies only when the third person continuing the business of
the dissolved partnership promises to pay the debts of the partnership. Otherwise,
creditors of the dissolved partnership have no claim on the person or partnership
continuing the business or its property unless the assignment can be set aside as a
fraud on creditors under paragraph 4.
(3) Prior right of dissolved partnership creditors as against purchaser.
When a retiring or deceased partner has sold his interest in the partnership
without a final settlement with creditors of the partnership, such creditors have an
equitable lien on the consideration paid to the retiring or deceased partner by the
purchaser thereof. This lien comes ahead of the claims of the separate creditors of
the retired or deceased partner. Application of the rule set forth in paragraph 3 does
and sometimes leaves the retiring or deceased partner with a continuing liability the
exact duration of which is not specified except that it shall apply only in favor of
those creditors at the time of the retirement or death of a partner. (Barrett & Seago,
op. cit., p. 480.)
Continuation of dissolved partnership business by another company.
(1) When corporation deemed a mere continuation of prior partnership.
The weight of authority supports the view that where a corporation was formed
by, and consisted of, members of a partnership whose business and property was
conveyed and transferred to the corporation for the purpose of continuing its
business, in payment for which corporate capital stock was issued, such corporation
is presumed to have assumed partnership debts and is prima facie liable therefor.
The reason for the rule is that the members of the partnership may be said to have
simply put a new coat, or taken on a corporate cloak, and the corporation is a mere
continuation of the partnership. (Laguna Transportation Co., Inc. vs. Social Security
System, 107 Phil. 833 [1960].)
(2) When obligations of company bought out considered assumed by vendee. In
some cases, when one company buys out another and continues the business of the
latter company, the buyer may be said to assume the obligations of the company
bought out when said obligations are not of considerable amount or value especially
when incurred in the ordinary course, and when the business of the latter is
continued.
However, when said obligation is of extraordinary value, and the company was
bought out not to continue its business but to stop its operation in order to
eliminate competition, it cannot be said that the vendee assumed all the obligations
of the rival company. (Phil. Air Lines, Inc. vs. Balinguit, 99 Phil. 486 [1956].)
Exemption from liability of individual property of deceased partner.
(1) Debts incurred by person or partnership continuing business.
The last paragraph of Article 1840 primarily deals with the exemption from
liability to creditors of a dissolved partnership of the individual property of the
deceased partner for debts contracted by the person or partnership which continues
the business using the partnership name or the name of the deceased partner as

part thereof. What the law contemplates is a hold-over situation preparatory to

formal reorganization.
(2) Commercial partnership continued after dissolution. Article 1840 treats more
of a commercial partnership with goodwill to protect rather than a professional
partnership (see Art. 1767, par. 2.) with no saleable goodwill but whose reputation
depends on the personal qualifications of its individual members. (In the Matter of
the Petition for Authority to Continue Use of the Firm Name Sycip, Salazar,
etc./Ozaeta, Romulo, etc., 92 SCRA 1 [1979].)
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 stipulation forbidding it, since the name of a commercial partnership
is a partnership asset inseparable from the goodwill of the firm. On the other hand,
a professional partnership the reputation of which depends on the individual skill of
the members, such as partnerships of attorneys or physicians, has no goodwill to be
distributed as a firm asset on its dissolution, however intrinsically valuable such skill
and reputation may be, especially where there is no provision in the partnership
agreement relating to goodwill as an asset. (Ibid., citing 60 Am. Jur. 2d 115.)
E. Liquidation and distribution of assets
1. general rules art. 1839

Art. 1839. In settling accounts between the partners after dissolution, the
following rules shall be observed, subject to any agreement to the
contrary:
(1)

The

assets

of

the

partnership

are:

(a) The partnership property,

(b) The contributions of the partners necessary for the payment of all the
liabilities specified in No. 2.
(2) The liabilities of the partnership shall rank in order of payment, as
follows:
(a) Those owing to creditors other than partners,
(b) Those owing to partners other than for capital and profits,
(c) Those owing to partners in respect of capital,
(d) Those owing to partners in respect of profits.
(3) The assets shall be applied in the order of their declaration in No. 1 of
this article to the satisfaction of the liabilities.

(4) The partners shall contribute, as provided by article 1797, the amount
necessary to satisfy the liabilities.
(5) An assignee for the benefit of creditors or any person appointed by the
court shall have the right to enforce the contributions specified in the
preceding number.
(6) Any partner or his legal representative shall have the right to enforce
the contributions specified in No. 4, to the extent of the amount which he
has paid in excess of his share of the liability.
(7) The individual property of a deceased partner shall be liable for the
contributions specified in No. 4.
(8) When partnership property and the individual properties of the
partners are in possession of a court for distribution, partnership creditors
shall have priority on partnership property and separate creditors on
individual property, saving the rights of lien or secured creditors.
(9) Where a partner has become insolvent or his estate is insolvent, the
claims against his separate property shall rank in the following order:
(a) Those owing to separate creditors;
(b) Those owing to partnership creditors;
(c) Those owing to partners by way of contribution. (n)

Liquidation and distribution of assets of dissolved partnership.

The process of winding up, where the business of the dissolved partnership is not
continued, consists in liquidating partnership property (turning it into cash), paying
outstanding debts, collecting outstanding receivables, distributing the proceeds,
and any other actions required to bring partnership business to a close. Until the
partnership accounts are determined, it cannot be determined how much any of the
partners is entitled, if at all.
Partners severally have the implied authority to sell partnership property and to
collect obligations due to the partnership. These powers may be delegated to one or
more of their number as liquidating partner or partners.
The law, however, does not require a partnership to convert all its assets into cash
before making a distribution to the partners.
It is within the power of the court to order a distribution of its assets in cash,
property, or a combination of both.
(1) Property which may be made available for distribution includes, in addition to
the partnership property, contributions which may be collected from the partners so
far as may be necessary for the payment of partnership obligations to creditors and
to partners. (Crane, op. cit., pp. 476477.)

(2) A partner has a right to have debts owing to the partnership from his co-partners
deducted from their respective shares. This right is called equitable lien or quasilien in American law.
It exists only when the affairs of the partnership are rounded up and the shares of
the partners are computed after dissolution.
(3) Each partner is entitled to a share in the surplus property of the partnership, if
any, in proportion to his interest in the partnership. (see Art. 1812.) This rule is
called the partners lien law in American law.
Rules in settling accounts between partners after dissolution.
Article 1839 sets forth a priority system for the distribution of partnership property
(see Art. 1810.) and individual property when a partnership is dissolved to those
entitled thereto.
The following rules as to distribution are subject to variation by agreement of the
partners, either in their original partnership agreement or in a dissolution
agreement (Ibid.), subject to the rights of partnership creditors.
(1) Assets of the partnership. They are:
(a) Partnership property (including goodwill); and
(b) Contributions of the partners necessary for the payment of all liabilities in
accordance with Article 1797.
(2) Order of application of the assets. The partnership assets shall be applied to
the satisfaction of the liabilities of the partnership in the following order:
(a) First, those owing to partnership creditors;
(b) Second, those owing to partners other than for capital and profits such as loans
given by the partners or advances for business expenses;
(c) Third, those owing for the return of the capital contributed by the partners; and
(d) Finally, if any partnership assets remain, they are distributed as profits to the
partners in the proportion in which profits are to be shared.
(3) Loans and advances made by partners. Loans and advances made by
partners to the partnership are not capital.
Nor are undivided profits, unless otherwise agreed. Capital contributions are
returnable only on dissolution, but loans are payable at maturity and accumulated
profits may be withdrawn at any time by consent of a majority. (Babb and Martin,
op. cit., p. 240.)
Amounts paid into the partnership in excess of a partners agreed capital
contributions constitute loans or advances which draw interest on which they are
made. Accumulated profits do not draw interest, as they are not regarded as loans
and advances merely because they are left with the fi rm. (Ibid., p. 248.)
(4) Capital contributed by partners. Capital represents a debt of the firm to the
contributing partners. If, on dissolution, partnership assets are insufficient to repay
capital investments, the deficit is a capital loss which requires contribution like any
other loss. (Ibid.) The return of the amount equivalent to the capital contribution of
each partner shall be increased by his share of undistributed profits or decreased by
his share of net losses.
A partner who furnishes no capital but contributes merely his skill and services is
not entitled to any part of the firm capital on dissolution in the absence of
agreement. He must look for his compensation to his share of the profits remaining
after repayment of the capital to the contributors. (Ibid., op. cit., p. 96, citing Mosely
vs. Taylor, 173 N.C. 286.)

The total capital contribution of the partners is not equivalent to the gross assets to
be distributed to the partners at the time of the dissolution of the partnership. It
may be impaired or become unavailable for distribution or return to the partners
because of losses sustained by the partnership. (see Villareal vs. Ramirez, 406 SCRA
145 [2003].)
(5) Right of a partner where assets insufficient. If the assets enumerated in No. 1
are insufficient (i.e., there is an overall loss), the deficit is a capital loss which
requires contribution like any other loss. Any partner or his legal representative (to
the extent of the amount which he has paid in excess of his share of the liability), or
any assignee for the benefit of creditors or any person appointed by the court, shall
have the right to enforce the contributions of the partners provided in Article 1797.
If any of the partners does not pay his share of the loss, the remaining partners
have to pay but they can sue the non-paying partner for indemnification.
(6) Liability of deceased partners individual property. The individual property of a
deceased partner shall be liable for his share of the contributions necessary to
satisfy the liabilities of the partnership incurred while he was a partner. (Arts. 1816,
1835, par. 3.)
(7) Priority to payment of partnership creditors/partners creditors.
When partnership property and the individual properties of the partners are in
possession of the court for distribution, partnership creditors shall first be paid from
partnership property and separate creditors from the individual properties of the
partners. (see Sec. 51, Act No. 1956 [The Insolvency Law], as amended.) Neither
class of creditors is allowed to trespass on the fund belonging to the other until the
claims of that other shall have been satisfied. (40 Am. Jur. 402-403.) Stated
otherwise, the general rule is: Partnership assets to partnership creditors,
individual assets to individual creditors; anything left from either goes to the other.
It involves the ranking of assets in a certain order toward the payment of
outstanding debts. This rule is known as the doctrine of the marshalling of assets.
In an American case, it was held that the United States does not have the right to
be paid its income taxes due from individual partners out of the assets of a
bankrupt firm in preference to the claim of partnership creditors. (United States vs.
Kauffman, 267 U.S. 408, cited by Teller, p. 120.) In line with the rule is the second
paragraph of Article 1835.
Suppose one is a creditor of all the partners solidarily on a transaction independent
of the partnership, may he, under the bankruptcy law, share pari passu with the
partnership creditors in its assets? No. This is so even though both the partnership
and its members are in bankruptcy. Having secured priority over the firm creditors
against the individual property of the firm members, the creditors are relegated to a
secondary position to the firm creditors, since the claim is not based on a firm
obligation. (In re Nashville Laundry Co., 240 Fed. 795, cited in Teller, p. 120.)
Furthermore, partnership is regarded as a legal entity separate and distinct from its
members.
(8) Distribution of property of insolvent partner. If a partner is insolvent, his
individual property shall be distributed as follows:
(a) First, to those owing to separate creditors;
(b) Then, to those owing to partnership creditors; and
(c) Lastly, to those owing to partners by way of contribution.
The preference of the individual creditors of a partner in the distribution of his
separate estate results, as a principle of equity, from the preference of partnership
creditors in the partnership funds. The separate creditor of an individual partner can

execute against the assets of the firm only to the extent of the interest of the
partner in the firm assets, which is nothing more than a right to any surplus
remaining after firm creditors have been paid. (Teller, op. cit., p. 121.)