Liquidating Distribution

Two limited partners each originally contributed equal amounts of capital and were each allocated a 25% ownership interest at formation. Over the years, due to different amounts of income and loss allocated to each under the partnership agreement's terms, their capital accounts have diverged significantly, even though their stated 25% ownership percentages have never changed. In liquidation, are these two limited partners' distributions based on their original 25% ownership percentages or on their current capital account balances?

1. A.On their current capital account balances, which reflect each partner's actual accumulated economic stake, not the original ownership percentageCorrect. Liquidating distributions follow actual capital account balances, which reflect each partner's real accumulated economic stake.
2. B.On their original 25% ownership percentages, since that figure was fixed at formation and does not changeWrong. Capital account balances, not the original static percentage, govern liquidation distributions.
3. C.Equally between the two, regardless of either their capital accounts or their original percentagesWrong. This is an invented, unsupported basis for the distribution.
4. D.On whichever of the two figures produces the larger distribution for each partnerWrong. This is an invented mechanism; liquidation distributions follow actual capital account balances, not whichever figure is more favorable.

Why: Liquidating distributions to partners are generally based on each partner's remaining capital account balance, not on an original, static ownership percentage that may no longer reflect each partner's actual economic stake after years of differing allocations. Capital accounts track each partner's contributions, allocated income, allocated losses, and prior distributions over time, and by the time of liquidation, two partners who started with identical ownership percentages can have meaningfully different capital account balances. Liquidation distributions follow those actual account balances, not the original percentage figure from formation.

A limited partnership is being liquidated. After paying off all outside creditors, funds remain. The general partner expects to receive her share of what remains before the limited partners recover their capital contributions, reasoning that she managed the program and bore unlimited liability throughout. Is this the standard liquidation priority?

1. A.Yes, general partners are always paid before limited partners in a liquidation, in recognition of their unlimited liability.Wrong. Unlimited liability does not translate into first-priority payment in liquidation; general partners are typically subordinated to limited partners' capital return.
2. B.Yes, but only if the general partner personally guaranteed partnership debt during the program's operation.Wrong. Whether the general partner personally guaranteed debt does not change the standard subordination of the general partner's liquidating distribution to the limited partners' capital return.
3. C.No, all partners, general and limited, are paid simultaneously and proportionally regardless of contribution or class.Wrong. Distributions are not simply pro rata across all partner classes; limited partners' capital return typically has priority over the general partner's liquidating distribution.
4. D.No -- the standard priority typically returns limited partners' capital contributions before the general partner receives a liquidating distribution, subordinating the general partner's interest to the limited partners' return of capital.Correct. Limited partners typically recover their capital contributions before the general partner receives a liquidating distribution, subordinating the general partner's interest.

Why: After outside creditors are paid, the usual liquidation priority calls for limited partners to receive a return of their capital contributions, and often any stated preferred return, before the general partner receives a liquidating distribution. This subordinates the general partner's interest to the limited partners' capital recovery, which is broadly consistent with the general partner's role as the party bearing unlimited liability and receiving compensation for managing the program over its life, rather than being first in line for a return of capital that was never the general partner's own money in the same way.

A limited partnership dissolves and begins winding up its affairs. Its assets, once liquidated, must be applied to pay claims in order of priority. The partnership has a secured lender holding a mortgage on partnership property, unsecured trade creditors owed for supplies, limited partners with capital accounts, and a general partner with a capital account. In what order are these claims generally satisfied?

1. A.Secured creditors, then general unsecured creditors, then limited partners, then the general partnerCorrect. This is the standard liquidation priority order: secured creditors, general creditors, limited partners, then the general partner last.
2. B.The general partner first, then limited partners, then secured creditors, then general unsecured creditorsWrong. This reverses the entire priority order; creditors of both kinds are paid well before any partner receives a distribution.
3. C.Limited partners and the general partner are paid simultaneously and proportionally, followed by all creditorsWrong. Creditors are paid before any partner, not after, and the general partner's claim ranks behind the limited partners' claims.
4. D.Secured creditors, then limited partners, then general unsecured creditors, then the general partnerWrong. This places limited partners ahead of general unsecured creditors, when both classes of creditors rank ahead of any partner's claim.

Why: The general order of priority in a partnership liquidation runs from secured creditors, who are paid from the specific collateral securing their claim, to general unsecured creditors, then to limited partners recovering their capital accounts, and finally to the general partner, whose capital account is paid last. This order reflects that creditors, whether secured or unsecured, generally rank ahead of any partner's equity interest, and that within the partners' own tier, the general partner's claim to a liquidating distribution is subordinated to the limited partners' claims. Each tier must generally be paid in full, or as full as available assets allow, before the next tier receives anything.