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Insolvency of a Partner – Garner vs Murray Rule

Introduction

If a partner becomes insolvent (bankrupt) during dissolution, he may clearly have a Debit balance in his capital account (Loss) which he cannot pay. Who bears this loss? The Solvent Partners. But in which ratio? This was settled in the landmark UK case Garner vs Murray (1903).

The Rule in Garner vs Murray

The Principle:

"The loss arising from the insolvency of a partner is a Capital Loss, and it must be borne by the solvent partners in their Capital Ratio (not Profit Sharing Ratio)."

Conditions for Applying the Rule:

  1. The solvent partners must bring in cash equal to their share of Realisation Loss.
  2. The deficiency of the insolvent partner is then distributed among solvent partners in the ratio of their Last Agreed Capitals.
    • Fixed Capital system: Ratio of Fixed Capital.
    • Fluctuating Capital system: Ratio of Adjusted Capital (Capital before Realisation loss).

Illustration

Fact: A, B, C share profits in 3:2:1. C becomes insolvent.

  • Capital Balances: A (60,000), B (40,000), C (Debit 20,000).
  • Realisation Loss: ₹30,000.
    • A shares: 15,000
    • B shares: 10,000
    • C shares: 5,000

Step 1: Solvent Partners bring Realisation Loss in Cash

  • Entry: Bank Dr 25,000 to A (15k) to B (10k).

Step 2: Determine C's Deficiency

  • C's Capital Debit: 20,000
  • Add Realisation Loss: 5,000
  • Total Deficiency: ₹25,000.

Step 3: Distribute Deficiency in Capital Ratio

  • A's Capital: 60,000. B's Capital: 40,000.
  • Ratio: 6:4 or 3:2.
  • A bears: 3/5 of 25,000 = 15,000.
  • B bears: 2/5 of 25,000 = 10,000.

Entry:

A's Capital A/c ...Dr 15,000
B's Capital A/c ...Dr 10,000
    To C's Capital A/c 25,000

Insolvency of ALL Partners

If all partners are insolvent, the creditors cannot be paid in full.

  • Realisation A/c is NOT prepared. Instead, a "Realisation Account" approach is not suitable because we can't pay liabilities.
  • We prepare a "Deficiency Account".
  • Creditors are paid whatever cash is available, and the unpaid balance is transferred to Deficiency A/c.

Exam Notes: Writing the Answer

Question: "Explain the rule of Garner vs Murray." (5 Marks)

Model Answer:

Origin: The rule originated from the case Garner vs Murray decided in 1903 in England.

Decision: Justice Joyce held that the loss due to insolvency of a partner is a Capital Loss (not a trading loss). Hence:

  1. Solvent partners must bring cash for their share of Realisation Loss.
  2. The Capital Deficiency of the insolvent partner is borne by solvent partners in their Capital Ratio (Adjusted Capital before Realisation Loss).

Applicability in India: This rule is applicable in India unless the Partnership Deed specifically mentions otherwise.

Summary

  • Nature: Capital Loss.
  • Bearer: Solvent Partners.
  • Ratio: Capital Ratio (NOT Profit Sharing Ratio).
  • Prerequisite: Solvent partners bring Realisation loss in cash.

Quiz Time! 🎯

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