Rowella Pty Ltd v Abfam Nominees Pty Ltd

Section 53 of the Mercantile Acts 1867-1896 Q. provides for the formation of limited partnerships for specified purposes including mining. By a deed dated 29 October 1984 the appellant, Rowella Pty. Ltd. ("Rowella"), and the respondents, whose names are set out in the first schedule to the deed, formed a limited partnership for mining purposes. Rowella was the general partner and the respondents were the special partners. The general partner contributed none of the capital; each of the special partners contributed one or more units of $10,000 to the capital of the partnership. The partnership business was to be carried on under the name or style of "Rowella Pty. Ltd. and Others". The Mercantile Acts contain specific provisions relating to limited partnerships including s. 54:

Every such partnership may consist of general partners who shall be jointly and severally responsible as general partners are now by law and of persons to be called special partners who shall contribute to the common stock specific sums in money as capital beyond which they shall not be responsible for any debt of the partnership except in the cases hereinafter provided for. Section 59 provides that the duration of a limited partnership should be not more than seven years, but the partners are empowered to renew the partnership for a further period. The deed provided for a seven-year renewable partnership. It has now been dissolved.

On the dissolution of the partnership a dispute arose between the general partner and the special partners as to their respective entitlements to the surplus assets of the partnership after the payment of the partnership debts and liabilities and the return of the capital contributed by the special partners. The deed contained no provision expressly dealing with the matter in dispute.

Section 5(3) of the Partnership Acts 1891-1965 Q. as it stood at the relevant time provided:

A limited partnership formed under the provisions of " The Mercantile Act of 1867 " is a partnership within the meaning of this Act, and the rules of law declared by this Act apply to such a limited partnership except so far as the express provisions of that Act are inconsistent with such rules. Section 5(3) thus applies s. 47 of the Partnership Acts to the settlement of accounts on the dissolution of a limited partnership. Section 47 provides: In settling accounts between the partners after a dissolution of partnership, the following rules shall, subject to any agreement, be observed: -

(1) Losses, including losses and deficiencies of capital, shall be paid first out of profits, next out of capital, and lastly, if necessary, by the partners individually in the proportion in which they were entitled to share profits.

(2) The assets of the firm including the sums, if any, contributed by the partners to make up losses or deficiencies of capital, shall be applied in the following manner and order: -

(a) In paying the debts and liabilities of the firm to persons who are not partners therein;

(b) In paying to each partner rateably what is due from the firm to him for advances as distinguished from capital;

(c) In paying to each partner rateably what is due from the firm to him in respect of capital;

(d) The ultimate residue, if any, shall be divided among the partners in the proportion in which profits are divisible.

The sum, the division of which is presently in dispute, is the "ultimate residue" of the partnership assets available for distribution after the application of those assets to the payment of the amounts specified under pars (a), (b) and (c) of s. 47(2).

Carter J., construing cl. 10 of the deed as entitling Rowella to 40 per cent of the profits, by application of par. (d) held Rowella to be entitled to 40 per cent of the ultimate residue. On appeal, the Full Court held that the ultimate residue is to be divided among the partners, not in the proportion in which profits were divisible while the partnership was carrying on its business, but in proportion to the partners' respective capital contributions. The appeal was allowed and a declaration was made that "after dissolution of the partnership ROWELLA PTY. LTD. is not entitled under the terms of the Deed of Partnership to share in the ultimate residue, if any, of the assets of the partnership".

Kelly S.P.J. (with the concurrence of Demack J.) appears to have treated the ultimate residue as "capital profits", distinct from the trading profits to which, in his Honour's view, cl. 10 related exclusively. His Honour held that "Rowella, having made no contribution to the capital, is not entitled to any share in it so that in the division of the capital profits as part of the assets on the termination of the partnership it is not entitled to share in those profits". One difficulty with this approach is that the ultimate residue to be distributed out of the assets of a partnership pursuant to s. 47(2)(d) is not in any relevant respect to be described as capital profits.

The capital of a partnership is, as Lindley on Partnership, 15th ed. (1984), p. 494, describes it:

the aggregate of the sums contributed by its members for the purpose of commencing or carrying on the partnership business, and intended to be risked by them in that business. The capital of a partnership is not therefore the same as its property: the capital is a sum fixed by the agreement of the partners; whilst the actual assets of the firm vary from day to day, and include everything belonging to the firm and having any money value. In McClelland v. Hyde [1] , Lord Andrews L.C.J., pointed out that "the capital of a partnership is something different from its property or its assets". That the capital of the partnership is different from the assets available on dissolution after payment of partnership debts is manifest from the terms of s. 47(2). Out of the assets of the firm, the partners are entitled to a return of the capital contributed in priority to any share in the "ultimate residue". In the present case, the distinction between capital and assets is clearly reflected in the deed of partnership: per cl. 5. 1. [1942] N.I. 1, at p. 7.

The ultimate residue is profit, but it is not capital. In Bishop v. Smyrna and Cassaba Railway Co. [2] , Kekewich J. pointed out that the term "profits" may bear different meanings:

The word "profits," like many other words in the English language, and even some of a technical character, is capable of more than one meaning, and it is often, and properly, used in more than one sense; and it seems to me that the two different senses of the word "profits" afford the key to the solution of the difficulty which I have now to deal with. In ordinary parlance, among mercantile men and lawyers, "profits" mean that sum which periodically, at the end of the half-year, or year, or other time fixed by agreement, is divisible among the partners - a term which, of course, includes members of a company - as income It is the sum which is ascertained by the taking of a proper account of what has been made by trading and is therefore distributable between the parties entitled. But the word "profits" is also used properly in this sense: when you come to wind up a concern, you have to pay all the debts; you have to repay to each partner what he has brought in as capital; and after that has all been done, if the concern has been a successful one, there is a balance, and that balance is "profit": it cannot properly be called anything else. And in McClelland v. Hyde [3] , Babington L.J. contrasted the capital of a partnership with its profits: Generally speaking, capital is the money, lands, goods or other property with which the company or partnership commences business. Anything acquired or earned over and above this in the course of business is not capital but profit. It may be earned directly by the capital, or by its means, or by the efforts of the partners or some of them, or by a combination of capital and work. It comes into existence after the business has commenced, having no prior existence, and whether it be earnings in money or kind or accretions to capital or goodwill, it is profit as distinguished from capital. 1. [1895] 2 Ch. 265, at pp. 269-270. 2. [1942] N.I., at p. 12.

Profits which are available for distribution as ultimate residue under par. (d) include any profits which, had the partnership continued, would have been divisible among the partners as trading profits. The ultimate residue to which par. (d) relates is the surplus remaining after external creditors have been paid (par. (a)) and the partners have received out of the assets of the partnership a return of the advances they have made and of the capital they contributed (pars (b) and (c)). The ultimate residue therefore does not include the capital of the partnership. Nor is it necessarily derived from the outlay of the capital contributed by the partners. Nor does it necessarily represent capital profits in the sense of profits derived on capital account, for the surplus assets may represent profits on capital account or profits on revenue account or profits of both kinds. Section 47 is not concerned with the distinction, familiar in taxation law, between assets acquired or disposed of on capital account and assets acquired or disposed of on revenue account. The ultimate residue is not relevantly to be described as capital profits of the partnership and, in the absence of contrary agreement, the Partnership Acts do not direct its distribution in accordance with the partners' capital contributions. The rule for distribution of the ultimate residue prescribed by par. (d) "subject to any agreement" is that it is divided among the partners "in the proportion in which profits are divisible".

McPherson J., the third member of the Full Court, held that there was an express or implied agreement "that the assets including capital belong to [the partners] in proportion to their capital contributions". His Honour construed cl. 10 as relating solely to the "annual distributable profits or income earned in the course of trading from year to year, but not govern[ing] the rights of the partners in surplus assets or "ultimate residue" on dissolution". He thought it would be odd if Rowella, having contributed none of the capital of the partnership, were to share in the ultimate residue after dissolution equally with the special partners (pursuant to s. 27 of the Partnership Acts); a fortiori, if Rowella were to share to the extent of 40 per cent (pursuant to cl. 10). The express or implied agreement which his Honour found does not appear to arise from any particular clause or group of clauses in the deed, but his Honour thought such an agreement to be "consistent with the equity of the matter and with the pre-Partnership Act cases" to which his Honour referred. The chief of these cases, to which Kelly S.P.J. also referred, was Griffith v. Paget [4] , a case which arose on the dissolution of a limited company, in which Jessel M.R. said [5] :

If in an ordinary commercial partnership one or more of the partners has a larger share of the profits than is the proportion borne by his share of the capital to the capital of the others, whether on account of his services (which is the more frequent ground, in cases of partnership, for giving the larger share), or on account of the services of others formerly given to the partnership, which is sometimes done, especially in the case of a second or third generation, that privilege ceases when the partnership is dissolved. If you give an annuity out of profits to a widow during the continuance of the partnership, she having no share of the capital, of course that, ex vi termini, will come to an end at the dissolution of the partnership. If you give a managing partner a salary, or a larger share of profits than his proportion of the capital, of course, at the dissolution, the management comes to an end and his larger share of profits.

But in the ordinary case, when the profits are unequally divided, - that is unequally, as regards the share of capital, - the same rule prevails, and that is quite independently of the circumstance whether the excess of profits is given for services, or given to a sleeping partner for the use of his name or otherwise.

When the partnership comes to an end, the right to the share of profits comes to an end also; and you distribute the assets, after providing for the profits earned up to the time of the dissolution, in proportion to the partners' shares of the partnership capital. That is the general rule of law in a commercial partnership. Therefore you would distribute the assets simply in proportion to the capital. This is a commercial partnership subject to certain statutory limits. Therefore, if there were no provision to be found anywhere, you would distribute the assets in proportion to the capital, and the mere arrangement for the division of profits inter se during the continuance of the partnership would have no direct bearing on the division of the capital as distinguished from profits earned up to the time of the dissolution after the dissolution of the company.

1. (1877) 6 Ch. D. 511. 2. (1877) 6 Ch. D., at pp. 515-516.

Uncharacteristically, Jessel M.R. does not make his meaning particularly clear. The assets to which his Lordship was referring at the beginning of the last quoted paragraph are the assets left "after providing for the profits earned up to the time of the dissolution"; that is, profits whether realized or not, and whether distributed or not. In this part of the last paragraph, Jessel M.R. seems to be speaking of the distribution of assets left after payment of the partnership debts and distribution of the partnership profits. So understood, his Lordship must have been speaking only of the return of capital which had been contributed. At the end of the last paragraph, Jessel M.R. seems to equate the assets available for distribution to the partners with "the capital" and to distinguish both from "profits earned up to the time of the dissolution". As we have seen, where the partnership has been profitable and some profits remain undistributed on dissolution, the assets available for distribution after payment of partnership debts include profits and therefore cannot be equated with "the capital", whether "capital" be understood as the capital of the partnership or whether it be understood as descriptive of the source of the assets available for distribution. But again, his Lordship may have been referring to the application of the assets of the partnership after the distribution of partnership profits, that is, to the return of capital (to which may be added any increment earned by investment of the partners' capital after dissolution and prior to its return to the partners). If this is what his Lordship meant, the passage assumes an abnormal order of application of partnership assets: debts, then profits, then capital. But if his Lordship was speaking of distribution of what was left after debts and profits, that must have been his meaning. And (as we shall see) that meaning is consistent with a view which his Lordship had earlier expressed.

No doubt the capital to which a partner is entitled after dissolution may be the source of some further profit and that further profit may then be attached to the capital which produced it, not as an asset of the partnership but as the yield on the capital which is taken on dissolution to belong to each partner. The assets of a partnership available for distribution to the partners as profit, capital having been returned, have not been understood to be divisible in proportion to the capital contributions of the partners rather than in the proportion to which they are entitled to the profits. In Watney v. Wells [6] there was a dissolution of a partnership in which profits were shared equally by partners who had contributed unequally to the capital. Lord Chelmsford L.C. held that, on the dissolution, the assets of the firm should be equally divided among the partners after returning the capital contributed by each of them together with the accumulations from dividends derived from the investment of that capital after dissolution and before return. He said [7] :

I think that each of the partners having the residue of his capital paid out of this fund must also be entitled to the accumulations which have been produced by the capital of each respectively; and these amounts being ascertained, the surplus of the fund (if any) will be divisible equally between the partners. And in Robinson v. Ashton; Ashton v. Robinson [8] , Jessel M.R. made a declaration of entitlement to surplus assets where the partners had contributed unequal amounts to the capital of the partnership but where each partner was entitled to one-half of the profits. His Lordship said [9] : There must be a declaration that Ashton [a partner] was entitled to one-half of the proceeds of sale after payment thereout of the debts of the partnership and the capital appearing by the books to be due to each partner. It is difficult to accept that Jessel M.R. would have departed consciously from the view he expressed in Robinson v. Ashton without referring to that case when, two years later, he made his observations in Griffith v. Paget. Whatever doubt be engendered by his observations on the later occasion, it was set at rest by the advice of the Privy Council in Binney v. Mutrie [10] . Binney, Mutrie and Currie were entitled under the partnership articles to share the profit and loss of the partnership in the proportions of 40, 35 and 25 respectively. This was not, however, the ratio of their respective contributions to capital [11] . Lord Hobhouse, speaking for the Privy Council, said [12] : Their Lordships understand that all claims of persons external to the partnership have been satisfied. That being so, it is clear that the surplus assets should be first applied in paying to each partner his claims in respect of capital. The residue will be profits, and will be divisible as such. Their Lordships then declared that after payment of the capital the residue should be divided in the proportions 40, 35 and 25: declaration "(g.)" [13] . One case prior to the Partnership Act where a distribution was made after dissolution in proportion to the capital contributed was Wood v. Scoles [14] , but that case "turned entirely on the construction of a special clause in the articles of partnership": Nowell v. Nowell [15] . The condition on which s. 47(2)(d) operates is that there is no superseding agreement governing the distribution of profits on dissolution. When the Partnership Act 1890 U.K., on which the Partnership Acts are based, adopted entitlement to profits as the basis of distribution of the ultimate surplus, that was seen merely as the translation into statutory form of what was then the accepted law: see Pollock on the Law of Partnership, 15th ed. (1952), p.xvi. The pre-Partnership Act cases are consistent with the statute. 1. (1867) L.R. 2 Ch. App. 250. 2. (1867) L.R. 2 Ch. App., at p. 253. 3. (1875) L.R. 20 Eq. 25. 4. (1875) L.R. 20 Eq., at p. 28. 5. (1886) 12 App. Cas. 160. 6. (1886) 12 App. Cas., at p. 163. 7. (1886) 12 App. Cas., at p. 165. 8. (1886) 12 App. Cas., at p. 166. 9. (1866) L.R. 1 Ch. App. 369. 10. (1869) L.R. 7 Eq. 538, at p. 541.

In this case, there are no special clauses of the deed dealing expressly with the distribution of surplus assets on dissolution. Nor, with respect, do the provisions of the deed generally imply that the ultimate residue should be distributed in proportion to the sums contributed as capital. If 40 per cent of the profits were to go to Rowella when distributions were made prior to dissolution but none of the profits were to go to Rowella on a distribution made after dissolution, the deed would have a curious operation. Prior to dissolution, distribution of profits was to be made annually: per cll. 7(b) and 10(d). Rowella would have been entitled to share in the next distribution in any profits which accumulated after the previous distribution, but Rowella would be excluded from sharing in them if the termination or earlier dissolution of the partnership intervened before the next distribution. If the financial year of the partnership ended immediately prior to the dissolution, cl. 10 would govern the distribution of those profits in respect of the financial year so ended. But if the partnership were dissolved on the day before the end of the financial year, the profits would be distributed quite differently: on the respondents' argument, among the special partners only. Section 42, which requires the property of the partnership to be applied in payment of the debts and liabilities of the firm and the surplus to be applied in payment of what is due to the partners respectively, would not affect that operation of the deed. The operation of the deed would be capricious.

As the deed contains no provision which governs the distribution of the "ultimate residue", s. 47(2)(d) requires the proportion in which "profits are divisible" to be ascertained. Where the partnership agreement provides for the proportions in which profits are divisible, the agreement furnishes the formula governing distribution under par. (d); otherwise one must look to s. 27 of the Partnership Acts which prescribes equality of division. In construing a contractual provision relating to profits, it is necessary to bear in mind that the term "profits" may bear a different meaning in a partnership agreement from the meaning it bears in par. (d). The contractual provision which is relevant to par. (d) is the provision which relates to the division among the partners of profits which the partners are entitled to retain on their own account, not on account of the partnership.

Rowella points to cl. 10(c)(ii) of the deed as the relevant stipulation which provides for the division of profits. The construction of that clause is critical to the resolution of this case. Paragraphs (a), (b) and (c) of cl. 10 read as follows:

(a) The net profits of the partnership shall mean the profits as determined by the general partner in accordance with generally accepted accounting principles.

(b) The general partner in its absolute discretion shall have the power to apply the whole or any part of the funds of the partnership including the whole or any part of the partnership net profits for any financial year in payment of any expense or liability incurred or undertaken by the partnership notwithstanding that such payment is not allowable as a deduction under any provision of the Income Tax Assessment Act for the purpose of calculating the partnership profits. The moneys available for distribution to the partners in respect of each financial year whether equal to the partnership net profits or being the balance remaining after payment from the partnership net profits of any expense or liability as aforesaid are hereinafter referred to as "the distributable profits".

(c) The distributable profits shall be distributed as follows: -

(i) The general partner shall make provision each quarter for an amount which shall be a provision for the future operating expenses of the general partner, and for the purpose of enabling the general partner to continue to act as a general partner and fulfil its obligations pursuant to this Agreement and the general partner shall deduct that amount thereof from the distributable profits before distribution of the balance as provided by the next sub-clause.

(ii) The balance of the distributable profits shall be paid as to forty percent (40%) thereof to the general partner, and as to the remaining sixty percent (60%) thereof to the special partners each of whom shall be entitled to receive that proportion of the remaining balance of the distributable profits as bears to that amount the same proportion that the number of units held by that special partner bears to the total number of units issued to all special partners.

provided however that no payment of any amount shall be made if the making thereof would contravene Section 61 of the Act.

It may be accepted that cl. 10(c)(ii) deals with the distribution of profits during the continuance of the partnership (see the reference to "each financial year" in par. (b)), but that does not preclude that provision from supplying the formula for distribution pursuant to s. 47(2)(d). Clause 10(c)(ii) contains the only provision relating to the distribution to the partners of profits which may be retained by them on their own account. The provisions of cl. 10(c)(i) do not entitle the general partner to retain the moneys received under that sub-paragraph for purposes other than the operating expenses of the general partner, that is, for the purposes of carrying on the partnership business. The "distributable profits" defined in cl. 10(b) are not synonymous with the "profits" to which s. 47(2)(d) refers. The only provision which relates to "profits" as that term is used in s. 47(2)(d) is cl. 10(c)(ii).

Carter J. was correct in regarding cl. 10(c)(ii) as providing the formula applicable under s. 47(2)(d) to the division of the ultimate residue. The appeal must be allowed, the judgment of the Full Court set aside, the appeal to that Court dismissed and the judgment of Carter J. restored.