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Liability when a firm becomes insolvent

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Paula, Fred, and Stephanie agree that Paula and Fred will form and conduct a partnership business and that Stephanie will become a partner in two years. Stephanie agrees to lend the firm $5,000 and take 10 percent of the profits in lieu of interest. Without Stephanie's knowledge, Paula and Fred tell Harold that Stephanie is a partner, and Harold, relying on Stephanie's sound financial status, gives the firm credit. The firm later becomes insolvent, and Harold seeks to hold Stephanie liable as a partner.

Should Harold succeed?

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Solution Preview

There are a few different issues in this case. Paula, Fred, and Stephanie all agree to the terms of the partnership. Stephanie will be a partner in two years, but all three parties now enter into the agreement to conduct a partnership. Additionally, Stephanie provides $5,000 for a 10% claim on the profits. We must make certain assumptions in this case, and we are assuming that Stephanie will begin receiving 10% of the profits now, and not in two years, because the $5,000 was invested now. Also, we have to note the wording. ...

Solution Summary

This solution discusses the case of Paula, Fred, and Stephanie. The facts regarding the succession of Harold are thoroughly analyzed and discussed.

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a. The firm had negative net income for the year

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c. Current Assets are less than Current Liabilities

d. The firm is insolvent

14. A firm which has a relatively large amount of cash and receivables in its current assets accounts and a relatively small amount of current liabilities would be considered:

a. liquid

b. profitable

c. risky

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13. If a firm's current ratio is less than 1.0, it indicates that:

a. The firm had negative net income for the year

b. The firm will be unable to pay its shortterm loans which come due this year

c. Current Assets are less than Current Liabilities

d. The firm is insolvent

14. A firm which has a relatively large amount of cash and receivables in its current assets accounts and a relatively small amount of current liabilities would be considered:

a. liquid

b. profitable

c. risky

d. nuts

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