1. Insolvency of a Partner

After winding up, if a partner's Capital Account shows a debit balance (they owe money to the firm — perhaps because their share of realisation loss exceeded their capital), that partner is said to be unable to pay — effectively insolvent for partnership purposes.

Treatment of Insolvent Partner's Deficiency — Garner vs Murray Rule

The Garner vs Murray case (1904) laid down the rule: when a partner is insolvent and cannot pay their deficiency, the solvent partners bear the loss in the ratio of their last agreed capitals — NOT in their profit-sharing ratio.

Garner vs Murray Rule: Deficiency of insolvent partner is borne by solvent partners in the ratio of their capital balances (at the time of dissolution — before writing off the loss), not profit-sharing ratio.

Step-by-Step Process

  1. Prepare Realisation Account → compute profit/loss on realisation
  2. Distribute realisation profit/loss to all partners in PSR (Capital A/cs)
  3. Identify which partner's Capital A/c shows a debit balance (insolvent)
  4. If insolvent partner cannot pay: write off their deficiency to solvent partners in ratio of their capitals (after adjusting for realisation P/L)
  5. Settle remaining solvent partners from Bank A/c

2. Worked Example — Insolvency under Garner vs Murray

A, B, C share profits 2:2:1. Dissolution. Realisation loss = ₹25,000. Capitals before dissolution: A = ₹15,000; B = ₹20,000; C = ₹8,000. Bank balance after paying creditors = ₹18,000.

Step 1 — Distribute realisation loss (PSR 2:2:1):

A: 25,000 × 2/5 = ₹10,000 loss; B: 25,000 × 2/5 = ₹10,000 loss; C: 25,000 × 1/5 = ₹5,000 loss

Step 2 — Capital A/cs after loss:

A: 15,000 − 10,000 = ₹5,000 (Cr); B: 20,000 − 10,000 = ₹10,000 (Cr); C: 8,000 − 5,000 = ₹3,000 (Cr)

Total capital = 5,000 + 10,000 + 3,000 = ₹18,000 = Bank balance ✓ (normal dissolution — no insolvency)

Insolvency Scenario

Same setup, but Realisation loss = ₹40,000 and C's capital = ₹5,000.

Loss to C = 40,000 × 1/5 = ₹8,000; C's capital = 5,000 → C's deficiency = ₹3,000

A: 15,000 − 16,000 = −₹1,000 (also insolvent!)… Let us adjust so only C is insolvent:

A = ₹20,000; B = ₹25,000; C = ₹5,000; Loss = ₹30,000; PSR = 2:2:1

A loss = 12,000 → A = 8,000 Cr; B loss = 12,000 → B = 13,000 Cr; C loss = 6,000 → C = 5,000−6,000 = −1,000 Dr

C is insolvent — cannot pay ₹1,000 deficiency.

Step 3 — Garner vs Murray: Deficiency ₹1,000 borne by A and B in ratio of their capitals (₹20,000 : ₹25,000 = 4:5)

A bears: 1,000 × 4/9 = ₹444; B bears: 1,000 × 5/9 = ₹556

Dr A's Capital A/c 444; B's Capital A/c 556 | Cr C's Capital A/c 1,000 (deficiency written off)

Final: A = 8,000 − 444 = ₹7,556; B = 13,000 − 556 = ₹12,444

Total paid to partners = 7,556 + 12,444 = ₹20,000 = Bank balance ✓

3. Piecemeal Distribution

In piecemeal distribution, assets are sold gradually and cash is distributed to partners after settling creditors, without waiting for all assets to be sold. Two methods:

Method 1 — Proportionate Capital Method (Maximum Loss Method)

Before distributing any cash to partners, compute the maximum possible loss if all unsold assets become worthless. Reduce each partner's capital by their share of this maximum loss. Distribute only what remains above zero to the partners whose reduced capital is still positive.

Method 2 — Highest Relative Capital Method

Partners with the highest capital relative to their profit share are paid first until all partners are at the same proportionate level. Then all are paid in PSR.