Dissolution with an Insolvent Partner: Applying Garner v. Murray

Realisation Account

Dr	₹	Cr	₹
To Stock	1,00,000	By Bank - stock	70,000
To Trade receivables	1,60,000	By Bank - receivables	1,48,000
To Machinery	2,20,000	By Bank - machinery	2,17,000
To Bank - expenses	15,000	By Trade payables (liability taken over)	1,50,000
To Bank - trade payables	1,50,000	By Loss on realisation transferred	60,000
	6,45,000		6,45,000

Note the treatment of creditors: they appear on both sides (taken over on credit, paid on debit) and cancel, so only the ₹60,000 net loss is passed on. Net loss = asset losses ₹45,000 + expenses ₹15,000.

Partners' Capital Accounts

	X ₹	Y ₹	Z ₹
Balance b/d	2,10,000	1,40,000	4,000
Less: loss 3:2:1	(30,000)	(20,000)	(10,000)
Balance after loss	1,80,000	1,20,000	(6,000)
Add: Z's deficiency in capital ratio 3:2	(3,600)	(2,400)	6,000
Amount paid	1,76,400	1,17,600	Nil

Bank Account

Dr	₹	Cr	₹
To Balance b/d	24,000	By Realisation - expenses	15,000
To Realisation - assets realised	4,35,000	By Realisation - trade payables	1,50,000
		By X's Capital	1,76,400
		By Y's Capital	1,17,600
	4,59,000		4,59,000

Check: capitals after loss total ₹3,00,000 less Z's ₹6,000 debit = ₹2,94,000, exactly the balance available. The account closes to nil.

Why not 3:2:1. Splitting the deficiency in the profit-sharing ratio would force Y to contribute towards Z's shortfall in the same proportion as X. That is the rule for ordinary losses, where every partner is assumed able to bear his share. Here Z cannot bear his share at all, so the loss must fall on those who can - otherwise the insolvent partner's share would simply go unpaid and the solvent partners' final balances would not clear.

The rule applied - Garner v. Murray. Where the deed is silent, the deficiency of an insolvent partner is borne by the solvent partners in the ratio of their capitals as finally adjusted (after the loss on realisation, before absorbing the deficiency), and not in the profit-sharing ratio.

Capitals after realisation loss: X ₹1,80,000, Y ₹1,20,000 → ratio 3 : 2 (which happens here to coincide with the old ratio; that is a coincidence of the figures, not the rule - if X's capital had been ₹1,50,000 and Y's ₹1,50,000, the deficiency would be halved).

X bears 6,000 × 3/5 = ₹3,600; Y bears 6,000 × 2/5 = ₹2,400.

If X were also insolvent. Garner v. Murray ceases to help, because the rule presupposes at least one solvent partner. Y would then be the only solvent partner and would have to bear the entire deficiency of both X and Z - his own capital would be wiped out first, and any residue left unpaid would simply remain unrecovered. The firm cannot compel payments from insolvent estates beyond what those estates actually pay.

One caveat to state: a few textbooks apply the capital ratio as it stood before the realisation loss. The figures here would then be 2,10,000 : 1,40,000 = 3 : 2, giving the same answer, so the settlement is unaffected.

Record the receipt, but do not treat it as a right of the firm. The firm's claim was against Z, and it was extinguished when X and Y absorbed the ₹6,000 deficiency between them; the brother owes the firm nothing and his offer is purely voluntary. There is no consideration and no enforceable obligation.

If the firm accepts the money:

Entry	Dr ₹	Cr ₹
Bank A/c Dr	6,000
To Z's Capital A/c		6,000

Z's capital account, which showed a debit of ₹6,000 after the deficiency was transferred, becomes nil. The ₹6,000 now sits in the bank and must be paid out to the partners in the ratio in which they bore the deficiency, i.e. X ₹3,600 and Y ₹2,400 - not 3:2 by coincidence of numbers but because that is the sharing ratio of the burden they carried. X and Y then receive ₹1,80,000 and ₹1,20,000 respectively, their full adjusted capitals.

Refuse the money if the brother attaches a condition (for example, that Z's name be cleared in the firm's records, or that the goodwill be revalued); a conditional payment is a new contract and needs all the partners' consent.

If Z later becomes solvent, he is bound to refund X and Y the ₹6,000 they contributed, in the ratio 3:2, because the deficiency was legally his and they discharged it. The firm's dissolution is complete, so he pays them personally.

Purely as a precaution, record the brother's ₹6,000 in the minutes as a voluntary contribution and not as a recovery, so that no creditor later argues that Z's estate had in fact paid.