Insolvency of Partner :
It is possible that after making entries relating to dissolution a partners capital account shows debit balance. If the partner is solvent then he will bring cash and settle his account. But if such a partner is declared insolvent then he will not be able to pay off his liability towards the firm. The deficiency will have to be met by other solvent partners. Now, one important question arises which ratio this deficiency will be borne by the remaining partners. Whether in the profit sharing ratio or in capital ratio? Before 1903 the partners used to share deficiency of an insolvent partner in profit sharing ratio. But in that year a British Court pronounced an important verdict in the case of Garner Vs. Murray establishing a new principle. According to this principle the deficiency of insolvent partner shall be borne by remaining partners in their capital ratio. The details and the principle laid down in the case are as under
Facts of the Case : Garner, Murray and Wilkins were partners. They were equal partners. The dissolution of the firm took place on 30th June, 1900 and assets of the firm were sold and creditors paid.
After all this firm’s status was as under:
Wilkins was declared insolvent and nothing could be realized. His total liability towards firm was £ 263 + (1/3 of £ 635) = £ 475. The question before the court was by which ratio should Garner and Murray share Willkins capital loss ?
Verdict Delivered in the Case:
It was pronounced that insolvent partner’s deficiency of capital shall be borne by remaining partners in the capital ratio showing in the balance sheet mad prior to dissolution of firm. The verdict was based on the principle that the loss arising out of insolvency of a partner is different from business loss.
Explanation of Verdict:
On the basis of verdict in the case following two points emerge out:
- Deficiency of capital of insolvent partner would be borne in their capital ratio.
- Solvent partners should bring in cash for their share of realization loss.
Capital ratio of the solvent partners would be derived from the regular balance sheet made prior to the dissolution of firm. For example, if firm’s balance sheet is made on 31st December every year then balance sheet made on 31st December prior to dissolution of firm would be used to find capital ratio for purpose. It is to be remembered that this capital can only be basis if capital account is fixed and not fluctuating. If capital accounts are fluctuating then adjustment will have to be made in partners’ capital account for reserves profit-loss account etc. But only prior to adjustment related to dissolution). The adjusted capital thus obtained would be used for sharing capital loss of the insolvent partner. It is to be remembered further that if there is debit balance in any partners’ capital account before distribution of realization loss then that partner will not share deficiency of insolvent partner.
[Note: In the absence of any information the question must be solved on the basis of Garner vs. Murray rule.]
