Defederalizing Partnership Break-Ups

Abstract

This Article discusses an important aspect of the collision of state partnership law with federal bankruptcy law as both apply to bankrupt partners. Partnership rules deal with agency costs among partners that result from the bankruptcy by providing for the dissociation of the bankrupt partner. However, the Bankruptcy Code's general non-enforcement of "ipso facto" clauses mandates continuation of the debtor as a partner and invalidates sub-market-value buyouts of the debtor's interest. This Article argues that state partnership law should control. Even if the Bankruptcy Code properly refuses to enforce ipso facto clauses generally, the rationale for non-enforcement does not apply to dissociation of bankrupt partners. Moreover, application of federal bankruptcy law has other costs, including creating perverse incentives to resort to bankruptcy, frustrating the agency- cost-reducing objectives of partnership law and, more generally, blocking potential benefits from customized contracts and state law evolution and variation.

JEL Classification: G33, G38, K22