In the absence of a partnership agreement to the contrary, a partner who departs an ongoing partnership is entitled to have the partnership buy out his or her interest. In Rappaport v. Gelfand, the California court of appeal rejected an argument that the value of a partner’s interest should be determined by assuming a one day liquidation sale. Instead, the court ruled that the buy out price should be determined by calculating the value of the partnership assets if those assets were sold by to a knowledgeable and willing seller, with neither being under any compulsion to buy or sell.
In Rappaport, a three person partnership had no agreement regarding a partner’s departure. When one partner left, he was entitled under California law to have the partnership pay him for his interest if the other partners wished to continue the partnership business. California law provides that the price is to be calculated at the greater of liquidation value or the value of the business as a going concern.
The parties’ evidence regarding value of the partnership assets differed considerably. The partnership assumed that the assets would be sold under “fire sale” circumstances at a one day liquidation sale. This approach resulted in a substantial discount to the book value of the assets. The departing partner assumed a sale of assets in an orderly process over time. This approach resulted in a small discount.
The Rappaport court ruled that the term “liquidation value” under applicable California law did not contemplate an immediate forced sale. Accordingly, the court approved the departing partner’s approach that assumed an orderly sale between willing and knowledgeable parties.
As noted above, California law permits partners to avoid these type of disputes by entering into an agreement regarding the partners’ rights and obligations upon the departure of a partner. Partners may agree on both the right of a departing partner to be compensated and the method of calculating the compensation.