Bitcoin Speculation and Demise

If you haven't heard of bitcoin yet you haven't been paying attention to monetary theorists, modern Austrian school economists, offshore financial service, anarchist, libertarian or fringe and speculative financial circles in the last year or two.

A summary of the bitcoin currency:

• It is a purely electronic currency
• The rules and institutions of the currency that recognise the validity of its issue and transfer (with or without subdivision and/or combination) are customary (a kind of customary law of the opt-in variety)
• Currency value is held in and transferable between and divisible between public keys which represent the 'accounts' in the system, by way of transfer messages signed by the private key of the public key of the account from where it came, nominating the payee(s) and amounts.
• Transfers are published and approved to form a block-chain, to so all users can track the balance held in each account (to confirm where the value came from) and where it has gone (to control the double-spend problem)
• The community accepts the longest block-chain as being valid, which means that the community accepts all the previously recorded and published transactions in the block chain
• Extending the block-chain requires computing resources to solve arbitrary mathematical problems. Whoever can find these solutions can extend the block chain and issue a pre-determined quantity of new currency as their reward for processing the new transactions and thereby cementing acceptance of the older transactions. The community only accepts block chain extensions that transfer value with the proper signatures from the originating accounts. 
• The identities and ownership and control of keys may be kept private or anonymous (i.e. the money is public (to control the double-spend problem) but the accounts where the money are held are not)

This system provides a basis for the currency to be secure and have a market value without having a central authority.

Because the currency is not issued in exchange for funds received by the issuer or owing by the issuer, and because the holder of the currency does not have any rights to redeem the currency against the issuer or to participate in any profits or assets of the issuer, the currency itself is not a debt security, nor an equity security, nor a bank note nor a negotiable instrument. Neither is it legally a form of currency or legal tender. It is a form of intangible personal property like ... like I'm not sure quite what. These features mean that it is typically not subject to any securities or banking laws, nor any AML laws. And even if it were to be within the definition of such laws, the ability of those laws to restrict or take legal action against the issuer or holder is rather moot: identifying and finding the issuer or holder is difficult and doing so will not stop others accepting or using it or mining more, and effecting confiscation may be difficult or impossible (e.g. with secret sharing as an antidote to the odious official key theft laws such as sec 130 of our very own Search and Surveillance 'law').

However, the lack of any issuance in exchange for assets and redemption in the form of assets means that its market value is determined by the combination of the quantity on issue (which is arbitrarily pre-determined by consensus in the community) and the demand to hold such currency. This can provide a determinate market value, but that value can be highly sensitive to the strength of the demand to hold the currency at any particular time. The actual market value has been highly volatile, and could now be driven largely by speculative fever, as suggested by this well written article:

I’m Raising My Bitcoin Price Target To $400

This article examines in some detail the potential for speculative mania in bitcoins.

The purpose of this post is to look further into the future as to what will replace bitcoin and how.

Firstly, note the consequence of price volatility in a currency: users of the currency will be hesitant to use it as a store of wealth, and will only use it as a speculative assets or for mediating actual trades. The vast wealth that now appears to exist in the form of bitcoins at the current market price will seek to migrate to other forms of wealth. Those other forms of wealth will not be denominated in bitcoins, either. Unlike gold and modern fiat currencies, credit markets in bitcoins will not emerge with any depth or liquidity or ubiquity.

Secondly, bitcoin users who are seeking alternative forms of wealth storage will expand markets for offshore financial services and for privacy enhanced (and confiscation resistant) wealth services. This expansion will be fueled by innovative offshore financial service providers who integrate their services with bitcoin.

Thirdly, the development and popularisation of bitcoin will put more pressure on AML laws and the FATF that will ultimately lead to acceptance or toleration of strong financial privacy, financial anonymity and asset protection. This is likely to be fueled by (and/or will fuel) a change in the tax mix from income tax to consumption taxes, and from progressive residence based income tax to flat rate source based income taxes, which reduces or eliminates the tax enforcement interest in personal and corporate offshore financial wealth holdings. This development will emerge through jurisdictional arbitrage and jurisdictional competition, and the breakdown of the FATF/OECD tax information cartel.

At the technical level, the bitcoin linking of 'mining' with approving transactions will be decoupled within bitcoin or by other similar currencies. The value-base of alternative currencies will move from mining economics to issue and redemption in exchange for commodities or financial assets. Commodities such as gold and silver provide the traditional market value anchor for currencies, and these could be restored in new digital currencies. The digital currencies will move back to being financial liabilities of issuers who will hold commodities and/or financial assets to be available to be used to redeem these liabilities. For this to happen, the current strangle-hold of restrictive securities laws and banking laws will have to be relaxed, and the AML laws will have to be scaled back to allow better financial privacy protections and to allow customer anonymity. These legal developments will only happen under considerable commercial pressure and by the re-emergence of more open jurisdictional arbitrage and jurisdictional competition (or alternatively the collapse of the state in a significant population area or areas).

Oram on Bank Failure Dynamics with OBR

Today's article by Rod Oram raises some valid points about how banking sector stress and failure could play out in New Zealand with the Reserve Bank's OBR policy being effected. The key concern:

[The] Reserve Bank has devised a rescue system that encourages depositors will flee their banks and try to head for the one it and the Government have saved.

This will happen for three obvious reasons under the Open Bank Resolution process due to take effect in June:

[1.] Depositors will be frightened by the Reserve Bank taking a proportion of a failed bank's deposits to recapitalise the institution. [2.] Failure is likely to be systemic and contagious in the event of, say, a collapse in the housing market or a drying up of international credit.

This means people will worry their banks and deposits will be next in line for treatment.

[3.] The Reserve Bank pledges it will make only a one-off "haircut" on deposits in the failed bank. It won't return for a second bite if the bank's problems deepen. This means new deposits in the rescued bank will retain their full value.

Oram also makes the point that bank customers and depositors are normally unsecured, while some wholesale creditors have security over high quality bank assets:

 Thanks to the Global Financial Crisis, commercial creditors are becoming more sophisticated in the collateral they are securing from banks.

An example here is covered bonds that are secured by ring-fenced high quality housing loans. BNZ introduced them in 2010 and other banks have followed with alacrity. While this security has lowered banks' funding costs, it's a moot point whether this has resulted in higher profits for the banks or lower borrowing costs for customers.

There are plenty of other ways New Zealand banks are ring-fencing assets to the benefit of their secured creditors, as David Tripe and Geoff Bertram analysed in an article in the November 2012 edition of the Policy Quarterly journal of Victoria University's Institute for Governance and Policy Studies.

Their analysis, available at http://bit.ly/10c3750, shows how secured creditors are gaining more protection for themselves should a bank collapse. This is leaving unsecured creditors bearing a growing share of the losses.

If you have deposited money in a bank, you are one of its unsecured creditors.

The result of these policies and practices together is that in the event of stress in the banking sector to the point of failure of one of more major banks is that market funding for surviving banks could become insufficient.

Counter-acting these concerns, during banking sector stress, the market price of funding for bank customers and borrowers can become significantly higher. This has two effects: it can make bank assets worth less, and it can rebuild or widen bank profit margins. This change in market price represents the transfer of some of the financial stress from the banks to the non-bank creditors: banks are, after all, credit intermediaries. Of course this natural and beneficial market pricing mechanism is the subject of much hand-wringing in a financial crisis: politicians and commentators want strong banks that continue to lend freely during periods of financial stress, but these two goals are in some conflict during periods of financial stress.

Another counter-acting force from this dynamic is the differences in bank strength in the financial system during periods of stress and failure. A bank does not fail by itself, it fails because bank customers and investors become sufficiently concerned about its health to cut off its funding. In doing this they will put their funds elsewhere, significantly including in other banks that are seen as stronger and less adversely affected by  the sources of losses revealed by the stress.

Finally, even in the event of the funds fleeing stronger banks for their weaker peers who have already failed and been restructured and now benefit from a government guarantee on their post-restructuring deposits, this does not mean the policy has not worked.  If the failed bank has converted enough of its debt into equity (or quasi-equity), the government guarantee would be needless and the bank would be able to attract funding even without the government guarantee, as happened in Australia in the 1890s. Further bank failures and restructurings progressively remedy the insolvency of such banks and does not imply that solvent banks will also fail, as can be seen from how that crisis played out:

The governments of Victoria and New South Wales passed controversial company laws that were designed to allow failed banks and other companies to more easily restructure their debts. After the failure of about 41 'land and building institutions' (think finance companies) in Sydney and Melbourne, the Federal Bank failed and the Commercial Bank of Australia was unable to attract or retain funding and suspended payment on 4th April 1893 and restructured its debts into preferred shares (30%) and long term deposits (70%) in a process that took around 8 weeks. Both banks had been lending to the failed land and building institutions. Even before the reconstruction took effect, the Commercial was able to attract funds from other banks by the financial innovation of providing trust-accounts-as-bank-accounts (of course in those days most payments to and from bank accounts were effected by cheques, which are made out to bearer or a named payee rather than a bank account number, so could be deposited anywhere):

A curious feature of the reconstruction, and one that was later copied by the other suspended banks, was the opening up by the Commercial, four days after it suspended, of trust accounts which enabled deposits and withdrawals to be made without involving any of the funds of the bank's 'old' business. These accounts undermined the banks that remained open, and there 'ensured the spectacle of depositors in bank still open, hastily withdrawing their funds to escape the threat of reconstruction and promptly depositing in a trust account in the Commercial' (Butlin 1961:300)

Quoted from Laissez faire banking, Free banking in Australia, K Dowd, p 134

The reconstruction, once effected was sufficiently successful to enable it to spread:

Every surviving bank had thrust before it the great advantages of 'reconstruction': permanent accession of capital; immediate elimination of the mounting tide of withdrawals; and miraculous restoration of confidence. Harassed and worried bankers ... followed the lead of the Commercial. (Butlin 1961: 300, as quoted in Dowd 1993: 134)

However, not all banks failed, suspended payment or went through reconstruction, in particular, the Bank of New South Wales (now Westpac), the Union Bank of Australia (now ANZ) and the Australasia (now also ANZ), even to the point of flouting government 'bank holidays' as a show of their strength.

The OBR IT pre-positioning enables New Zealand banks to effect similar reconstructions by the start of the next business day after failure, and with significantly less disruption than in the 1890s.

Mr Oram's concerns could be addressed by the following changes:

Firstly, the capital requirements for banks could be higher, and met by larger amounts of subordinated debt. This type of funding is good for absorbing losses in a restructuring or OBR situation ahead of ordinary depositors and bank customers. Subordinated debt is still a kind of debt finance (for tax and financial reporting purposes), so it is not a limit on leverage. However, it is a kind of funding that exposes the bank to close market discipline and losses can be applied to it without any political or popular concerns. Ideally, it should be convertible to ordinary share capital in a stress situation to assist raising further ordinary share capital. Higher total capital requirements would make bank failures rarer, and reduce the emphasis on liquidity regulation. There could also be a capital surcharge for secured borrowings to compensate unsecured creditors for their subordination.

Secondly, the core funding requirement should be reduced in quantity but increased in quality. Presently it is 75% of the bank net loans and advances, however, it can be made up from super-senior (secured) wholesale funding (such as covered bonds), as well as call funding and funding that matures in the short term (so called 'non-market funding' of less than $5m/customer (or is it per facility?)). So, in the event the bank is subject to stress, the super-senior funding such as covered bonds is not available to absorb any losses in a restructuring, and the call funding will run off (notwithstanding it is supposed to be 'sticky' retail funding), leaving the remaining depositors to absorb any losses in a restructuring after shareholders and subordinated creditors. One of the lessons from the Global Financial Crisis is that retail bank runs still happen notwithstanding deposit insurance (e.g. Northern Rock), but the RBNZ boffins think that without deposit insurance retail customers are going to leave their life savings at call with a stressed bank. The true core funding is funding that is subordinated to or ranks equal with ordinary depositors, and that does not mature in the short term (6-12 months). So this should only include share capital, subordinated debt, and unsecured funding that does not mature for 6-12 months or more.  If this definition was made more strict, the quantity required should also be substantially reduced, e.g. to 40-50%. If the bank is going to fail anyway, the call funding will run off and the term funding will mature over time leading to default. At the time of default, if the bank still has a partial remainder of true core funding, and a larger extent of subordinated debt, the losses to be shared by the depositors at the time of failure will be significantly lower.

Thirdly, the OBR procedures should be designed to be feasible and effective even without a government guarantee for the post-haircut balances, for example if the government is insolvent at the time the bank failed.  

Politics of Modern Bank Failures

The Cyprus bank failures and restructurings gives some insights into the fraught politics of bail-outs and bail-ins. Five features are notable from the way this saga was handled:

1. Risk is being moved from the government to investors. Governments, national and supra-national, have their own solvency concerns, and wish to push back risks and losses to bank investors. The public, political and bureaucratic appetite for governments to carry the losses are now weak.  This includes both for insolvent banks and for insolvent governments within the Eurozone and EU.

"What we've done last night is what I call pushing back the risks," Dutch Finance Minister Jeroen Dijsselbloem, who heads the Eurogroup of euro zone finance ministers, told Reuters and the Financial Times on Monday, hours after the deal was struck.

"If there is a risk in a bank, our first question should be 'Okay, what are you in the bank going to do about that? What can you do to recapitalize yourself?'. If the bank can't do it, then we'll talk to the shareholders and the bondholders, we'll ask them to contribute in recapitalizing the bank, and if necessary the uninsured deposit holders," he said.

2. Bank resolution and restructuring powers held by governments and government agencies are being used as a way to overcome political legislative difficulties. These powers are extensive and involve discretion, and may have unpredictable results, but they are being used.

The legislation needed to complete the restructuring of the Cypriot banking system is already in place, German Finance Minister Wolfgang Schaeuble said in the early hours of Monday morning.

Speaking after euro-zone finance ministers approved a new bailout deal for Cyprus, Mr. Schaeuble said "the necessary laws have already been enacted."

He said a banking levy--as was agreed under a now-discarded agreement made just eight days ago--would have required the Cypriot parliament to pass fresh legislation.

3. Taxes on deposits are politically unpalatable. The substance may be desirable, but the form is not. Bank restructuring, closures and resolutions are more appropriate and are doable notwithstanding political difficulties.

The Cypriot parliament rejected a planned levy on bank deposits on Tuesday, throwing a European bailout plan for the tiny economy into disarray.

The vote was overwhelming, 36 with against and 19 abstentions, and brings Cyprus to the brink of financial collapse.

4. Large depositors and creditors of banks get screwed to save 'mum and dad' savers.

Cyprus's finance minister said Tuesday that large deposit holders at Cyprus Popular Bank PCL (CPB.CP), the island's second biggest lender, could face losses of as much as 80% on their deposits as the government moves to wind down its operations.

Speaking in a television interview with state broadcaster RIC, Michalis Sarris indicated that it could also take years before those depositors see any of their money returned.

"Realistically, very little will be returned," Mr. Sarris said.

Asked if, like in other bank closures, it could take six to seven years before depositors get back there money, he said: "maybe yes. And the amount [returned], could be 20%. Certainly, for depositors above 100,000 euros it could be a very significant blow."

His remarks come just hours after Cyprus's central bank governor estimated that the losses facing large depositors at rival Bank of Cyprus PCL (BOCY.CP), could reach as much as 40%.

Wholesale investors beware. Banks cannot rely on wholesale funding in times of stress, and wholesale funding costs must include an additional risk premium based on the prospect of losing up to 100% of the investment should the bank fail. The losses to be faced by large depositors are as a result of saving small depositors from taking any losses at all:

After 12 hours of talks with the EU and IMF, Cyprus agreed to shut down its second largest bank, with insured deposits - those below 100,000 euros - moved to the Bank of Cyprus, the country's largest lender. Uninsured deposits, those accounts with more than 100,000 euros, face losses of 4.2 billion euros.

Uninsured depositors in the Bank of Cyprus will have their accounts frozen while the bank is restructured and recapitalized. Any capital that is needed to strengthen the bank will be drawn from accounts above 100,000 euros.

5. Capital controls may be introduced even though they are pointless and unnecessary. They signal that the banks have not been restructured into a viable form and that the funding provided in the resolution transaction is inadequate, even though this is probably not really the case.

Five lessons from Cyprus

While the Cyprus sovereign and bank insolvencies fester unresolved a week later, the twists and turns along the way provides some lessons for resolving bank and sovereign insolvencies:

1. Uncertainty matters. Bank customers all over the Eurozone now have little confidence about what would or could happen in the event of bank failure and where the losses will be be visited. This uncertainty must be addressed by clear, binding rules and institutions that are feasible regardless of whether the state and any deposit insurance schemes are insolvent at the same time. On the other hand it also means that bank creditors need to monitor the financial condition of the banks and the states where they operate from.
2. Institutional investors and large depositors are vulnerable. When the losses are allocated politically, 'mum and dad' savers have more clout per dollar exposure to the bank than large corporations and rich foreigners who can't vote. (Recent news is that those with under Euro 100k will be spared 6.7% haircuts and haircuts for those with bigger deposits is being put up from 9.9% to 25%.) The misnamed and unnecessary 'de minimis' facility in New Zealand's OBR pre-positioning spec is a political licence to screw institutional investors to spare everyone else, and thereby cut off wholesale funding to NZ banks at their time of stress. The absolute priority and pari passu rules must be protected to avoid this kind of problem. 
3. Time is of the essence. As days turn into weeks, the disruption to bank customers mounts and these costs cannot be undone at a later stage. Bank resolution institutions needs to be ready in advance and feasible to effect within a few days and without long decision making delays. 
4. When the government in insolvent, nothing is safe, but some assets and interests are more vulnerable than others. Governments can tax anything and at any rate, but some kinds of assets are more closely connected to the state and/or more easily within reach of the state. With Cyprus reportedly nationalising state pensions, this is a good example of the kind of assets that are most exposed. Pension and state mandated or tax-favoured retirement savings are examples of vulnerable assets (e.g. Kiwisaver funds). By contrast, real estate and private share portfolios are administratively and practically more difficult to seize or tax. 
5. European political conditions and style prioritizes sharing of losses not only with tax payers but also investors and nations. Bail-outs at all costs are no longer in vogue. European politics has now caught up with economic reality that short term 'stability' measures are likely to be catastrophic long term. Investors, politicians, regulators and citizens now have to adapt to a world and a Europe where sovereign and bank debt is risky, and where failed banks and insolvent states get restructured at the expense (or partial expense) of their creditors. 

A Quasi-Open Bank Resolution in Cyprus

The news that Cyprus bank depositors are taking a haircut in the restructuring and refinancing of the Cyprus banks is a step closer to seeing the New Zealand Open Bank Resolution plan becoming a feasible option for bank failures around the world. The fact that this kind of option is being sought out and effected in a nation-wide financial and banking crisis is also remarkable, although thankfully to be more expected when both the state and the banks are insolvent at the same time. Ironically, the Cyprus banks are reported to be insolvent because they took heavy losses from lending to the Greek government.

Another remarkable point is that the bank depositors are getting bank equity in exchange for the haircut portion of their deposits: this is a real recapitalisation rather than a selective default (which is the position for the New Zealand OBR scheme). Whether they get equity in their own bank or in the Cyprus banks as a whole is not clear from the new story I linked to earlier.

Effecting bank creditor recapitalisations on a bank by bank basis as or if required should also be seen as a preferable option, as creditors of viable and solvent banks are spared the haircuts, and the banking system as a whole continues to operate without interruption even if the state and many of the banks in the financial system fail. Credit risk in this way become more institution specific, and avoids being nationalised.

Customers of offshore banking centers have suffered several times in the recent financial crisis, including in Cyprus and Iceland. Where a jurisdiction has a large offshore banking sector in relation to its domestic economy, the state may be unable or unwilling to rescue its banks should they become insolvent. Ironically, the Cyprus bank restructuring is also a good reason for using offshore banks: Cypriot customers banking with Cyprus banks have suffered haircuts simply because they banked within their own country (although foreigners banking with Cyprus banks also suffered in the same way). Offshore banking customers, as with their domestic counterparts, need to consider the financial risks they face both from insolvent banks and from insolvent states. Offshore accounts held with strong banks and fiscally strong states such as Singapore and Hong Kong are safer than those held with weaker banks with weaker states such as Belize.

Mary Poppins lesson on banking

Unexpected lesson on banking from the Mary Poppins movie:

The Emergence of Partnerships as Real Entities

It remains standard law that partnerships are mere aggregates, nothing more than the partners of which they are composed. Yet the development and evolution of partnerships, partnership law and partnership accounting has actually progressed fairly well down the path to legally recognising partnerships as real entities.

This post seeks to introduce and document these developments and suggest where and how it might have ended up should these developments continue (although it is unlikely that they will given how inflexible the common law has become under the Royal/state rationalisation of the judiciary and the stare decisis doctrine and the legislative provision for open business incorporation and other legislative limited liability and separate legal entity vehicles).

Sole Proprietorships

Before addressing the law on partnerships I will begin with the sole proprietorship. Under the entity concept of accounting, the business of the sole proprietor is accounted for separately from the sole proprietor's other transactions. Although a sole proprietorship may be a separate entity for accounting purposes, most sole proprietorships would not be accounting entities under common law or customary law because the proprietor is not required to account to anyone and therefore would not normally prepare financial accounts. Of course there are situations where a sole proprietor is required to render and therefore prepare accounts, for example if specified under the terms of a bank loan, or, for income tax purposes, but these are not inherent in the concept or practice of a sole proprietorship. The same applies where the proprietorship chooses to keep accounting records and prepare accounts for management purposes. The keeping and preparation of accounts for a sole proprietorship business generally has no legal application or impact because the simplicity of the structure eliminates all legal relations between equity investors, and there is no practical or theoretical reason why creditors remedies could differ between the business assets and the personal assets. So, the sole proprietorship always has been legally and financially indistinguishable from the sole proprietor himself, and probably always will be.

Partnerships if the aggregate theory is strictly applied

To introduce partnership law and practice I will begin by assuming that the law does not recognise the partnership as a separate entity, and strictly maintains the 'aggregate theory'. This is nothing more than a starting position, but by laying it out the significance of the shifts from this approach can be made more apparent.

Before detailing the key legal position that follows from the aggregate theory I will address the accounting entity status of the partnership. Unlike sole proprietorships, all partnerships are separate entities for accounting purposes and partners have a universal legal obligation to account to each other, and prepare financial accounts for this purpose. The obligation account and advances in the practice of accountancy and the use of accounting information by creditors and others is one of the factors that supports the development along the direction of treating partnerships as real and separate legal entities. More on that later.

The partnership structure introduces some legal issues that the sole proprietorship does not. Agency law will simply be assumed to be available and recognised and applied in the standard manner: the partners are principals and each is agent for all the other partners for transactions within the scope of the partnership business. Obligations entered into in this way (or by all the partners acting together and without relying on agency) are joint and several.

This brings us to the first legal issue: what does this mean? In the simplest terms, it means a creditor can enforce the obligation against any or all of the partners. Since the partnership is a non-entity, the partnership obligations are good as against any partner and the creditor can chase and collect from any partner and from all partners until the debt is paid, and has all the remedies he would have if it were a non-partnership debt. So he can chase any of the partners in any order he wants and keep going until the debt is paid or all the partners have exhausted whatever is available for creditors.

Any amounts paid or collected from the partners in excess of his share of the obligation gives the partners rights against the other partners to recover from them. This is called an indemnity.

However, the if we apply the aggregate theory to the partnership assets and liabilities when all the partners cannot pay all their liabilities in full, the partnership does not have any of its own assets or liabilities since it is a non-entity. There is no partnership estate, instead all the assets and the liabilities must be disaggregated and considered part of the partner's separate estates. This has the effect of making the debts several rather than joint. To see how this position should arise, consider the case where:

1. there are 2 partners
2. the partnership has no assets (i.e. no assets jointly owned by the partners)
3. the partners have incurred joint liabilities
4. 1 partner cannot pay, and enters some kind of insolvency administration
5. the creditor then proceeds against the other partner who pays and remains solvent.

In this case the partner who paid is entitled to an indemnity from the insolvent partner for the insolvent partner's share of the debt he paid. He ranks as a creditor of the partner for the amount of the indemnity, he does not stand in the shoes of the original creditor claiming the full amount of the partnership debt.

If both partners cannot pay, however, we have 2 insolvent estates, 1 for each partner. Again, by assumption there is no partnership estate, because the partnership is a mere aggregate and so we have to some how disaggregate the partnership assets and liabilities back to the partners' individual estates. The key question is how the partnership creditor's claim is disaggregated back to the partners' estates. Claiming the full amount from both estates seems like double-dipping and disadvantages the separate creditors, so the fair alternative disaggregation method would be to claim each partner's equitable share of the debt from each estate. This puts the creditor in the same situation of the partner with an indemnity mentioned above. A worked example of this (hypothetical) rule is below.

In this example Smith has a 90% share in the partnership, and the partnership deficiency was large in relation to his non-partnership estate, so when 90% of the partnership deficiency was apportioned to his estate, only a very small dividend rate was paid to his separate creditors, and the partnership creditor also ended up with a low overall dividend rate. By contrast Jones had only a 10% share of the partnership, so only 10% of the partnership deficiency went to his estate, and as his estate was larger, his separate creditors got almost all of their entitlements paid, and most of the 10% share of the partnership deficiency was also paid.

If we add any joint assets into the mix, we have to disaggregate partnership assets by profit share and include them in the separate estates, in addition to doing this for the liabilities. Adjusting the worked example with joint assets:

 We can't apply the joint assets to the joint liabilities and then disaggregate the deficiency apply to the partners' estates for two reasons:

1. It would imply that the partnership was being treated as a separate estate when, by assumption the partnership is a non-entity and does not have its own estate, and
2. It would change the distribution of recoveries between separate and joint creditors (if it did not impact the result it would be allowable as an expedient administrative step).

To demonstrate the impact on the distribution of recoveries note that if we apply the $10,000 in joint assets to the joint liabilities, the remaining debt matches the first worked example and gives a recovery to the joint creditor of $10,000 + $1,115.98 which is more than the $10,999.17 calculated above.

What is the effect of this rule? It is not correct to say that it makes partnership liabilities several (i.e. proportionate to profit share proportion). The debts remain both joint and several. Should any partner be able to pay his own non-partnership creditors in full, and his own share of the partnership debt, he remains liable for the the shares of the other partners. It is only when a partner cannot pay his share of the partnership debt that the other partners (if they pay) or the creditors (if they don't) are limited to claiming the partner's share of the debt.

Another effect of the rule is that transfers of assets between the partners and the partnership potentially does not impact on the estates of any of the partners or the rights and remedies of creditors -- since the procedure allocates all the assets and liabilities back to the partners in gross, and there is no separate partnership estate.

Partnership Estates and the Jingle Rule

The above account of partnership liabilities is quite different from where the law has actually ended up. I'm not sure if it even started in the position I outlined or even passed by it.

Although in theory English common law maintains that the partnership firm is not a legal entity, and is a mere aggregate, in practice it is treated as a legally separate fund, a separate estate similar to a trust. The effect of this development is to improve the independence of the partnership from the affairs of the partners, and to develop the partnership form as a kind of financial entity that counter-parties can deal with separately from the partners.

The key legal rule that recognises the partnership assets and liabilities as a separate estate is called the jingle rule, and provides that:

The joint creditors shall be first paid out of the partnership or joint estate, and the separate
creditors out of the separate estate of each partner, and if there be a surplus of the joint estate,
besides what will pay the joint creditors, the same shall be applied to pay the separate creditors, and if there be on the other hand a surplus of the separate estate, beyond what will satisfy the separate creditors, it shall go to supply any deficiency that may remain as to the joint creditors. (Lord King C in Ex parte Cook in 1728)

These rules are still in effect today as can be seen from:

1. All property and rights and interests in property originally brought into the partnership stock, or acquired (whether by purchase or otherwise) on account of the firm or for the purposes and in the course of the partnership business, are called in this Act partnership property, and must be held and applied by the partners exclusively for the purposes of the partnership and in accordance with the partnership agreement (sec 23, Partnership Act 1908)
2. On the dissolution of a partnership every partner is entitled as against the other partners in the firm, and all persons claiming through them in respect of their interests as partners, to have the property of the partnership applied in payment of the debts and liabilities of the firm, and to have the surplus assets after such payment applied in payment of what may be due to the partners respectively after deducting what may be due from them as partners of the firm; and for that purpose any partner or his representatives may, on the termination of the partnership, apply to the Court to wind up the business and affairs of the firm. (sec 42, Partnership Act 1908)
3. If a person (A) is a partner of a firm and is adjudicated bankrupt, any creditors to whom A is indebted jointly with the other partners of the firm must not receive any money obtained from the realisation of the separate property of A until all the separate creditors have had their claims paid in full (sec 279, Insolvency Act 2006) 

This means that the partnership estate is separate from the individual estates of the partners, and there is no need to disaggregate or attribute the partnership assets and liabilities back to the individual partners to include in their estates. The position of the partner shifts a considerable distance away from principal (holus bolus) and a substantially closer to a contributory or guarantor. The partner's estate is only on the hook in net terms (for any surplus on realisation), and only to the extent that the partnership cannot pay its liabilities with its own assets.

From a credit risk and financial point of view, creditors of the partnership are in a weaker position than the creditors of a sole proprietor because they cannot access the personal assets of the partner without first seeing that the personal creditors of the partner are satisfied. Business creditors of the sole proprietor have equal rights and access to business and personal assets along with his personal creditors.  The primary recourse of the partnership creditor is the partnership assets, with the personal credit of the partners as a vulnerable back up that may effectively evaporate when it is needed most. Partnership creditors must therefore rely to a greater extent on the trading viability and adequacy of partnership assets, and to a lesser extent on the personal covenant of the partners. The partnership is more of an independent financial entity, a collective business vehicle that ought to be endowed with adequate financial capital if it is to stand on its own two feet in the commercial world.

However, at the more practical level the full meaning and effect of this parallel estates doctrine has not quite fully overpowered other institutions that aren't in line with it.

Access to partnership assets by partner's separate creditors has long been off limits. The remedy of the creditor of the partner seeking to access the partnership assets is limited to a charging order on the debtor partner's interest. The other partners and the partnership business are protected from the separate debts of the partners. This approach recognises that the partnership estate is legally separate, and that the partner's interest in the partnership is in the equity in the partnership and his share of the profits and other distributions he is entitled to as partner. The partner's creditor has to wait for the partnership to decide what to pay out, if anything, according to the terms of the partnership agreement and the management decisions of the partners.

However, there is no protection at all when it's the other way around. Partnership debts can be enforced against separate assets of any of the partners. And this appears to be the most glaring procedural rule that is not in line with the jingle rule. The partnership creditor's remedy should be first against the partnership assets, and only, on deficiency of that remedy should the partner's personal assets become available, and even then only after paying or providing for the separate creditors of the partner, as per the situation under the jingle rule. By way of contrast, the general partner of a limited partnership formed under the Limited Partnerships Act 2008, is not liable for the debts of the partnership except to the extent that the Limited Partnership cannot pay (whether the general partner's separate debts need to be paid first I'm not sure).

The legal and commercial development of the partnership as a separate financial entity is also consistent with the development and acceptance of a business structure that expressly limits creditors rights to their primary recourse: the partnership estate. Of course this should merely be an option for partners and their creditors to use, but it would appear to be likely to be in demand (especially in the absence of statutory limited liability and incorporation under companies legislation).

The development of the jingle rule under early equity jurisprudence is discussed by Joshua Getzler and Michael Macnair in The Firm as an Entity before the Companies Acts.