What is The Domino Effect in respect to Partnerships?
Trading as a partnership can carry some tax rewards and other benefits but when things go wrong, or the partnership becomes insolvent (or even if an individual partner becomes insolvent) a partnership can be a nightmare to deal with.
It is vital to understand that the partnership is made up of several components. The components are the individual partners, all of them, and the partnership itself.
If a partner as an individual has an insolvency problem, perhaps from overspending/borrowing, gambling or drinking (or all of these) and is being pursued by a creditor(s) this can lead to problems. It is even possible for the spouse of a partner to become insolvent, thus leading to the loss of the matrimonial home which, for example, may underpin security granted to a bank.
If a debtor (partner/spouse) is issued with a County Court Judgment or Statutory Demand and this remains unsatisfied, the creditor can notify the partnership of this outstanding debt and ask for the partnership to pay it. This is grounds to issue a petition to wind up the partnership if the debt is not paid.
Therefore, the creditor can effectively bring down the partnership. If for example the meltdown of assets in liquidation allied to an increase in creditors claims (eg from landlords and employees) means that there are insufficient assets in the partnership to satisfy the debts the individual partners will be required to make up the shortfall.
If the shortfall is large enough it could lead to the individual bankruptcy of one or all the partners. Finally such an event may lead to the loss of the matrimonial home of the individual partners to make up the shortfall in the personal estate or to make higher payments to creditors.
This domino effect can be catastrophic for assets, individuals and families. To understand how the domino effect may be an issue for your partnership please see the Domino effect flowchart (.pdf)
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Please note that the guide was mostly written pre Covid-19 and there have been some changes to insolvency legislation that limits creditors actions and relaxes rules regarding wrongful trading. A new 20 day moratorium for distressed businesses has also been introduced.