Formation and Dissolution of Partnership Firm | Law Optional Notes for UPSC PDF Download

Introduction

The Indian Partnership Act was established in 1932, officially coming into effect on October 1, 1932.

Section 4 of the Partnership Firm Act of 1932 provides the definition of a partnership. It pertains to the relationship between individuals who have mutually agreed to partake in the profits of a business that is conducted by any or all of them on behalf of the group.

To clarify, the key elements of this section include the following:

• A contractual relationship or understanding must exist.
• There must be a minimum of two individuals involved.
• These individuals must agree to share the profits of a business that is managed by any one of them or all of them representing the entire group.

In a partnership firm, there are several partners, with a minimum requirement of two partners and a maximum limit of 10 partners for banking businesses and 20 partners for non-banking businesses.

The distribution of profits and losses in a partnership firm is divided among all the partners. The partners come to an agreement on how these profits and losses will be shared. A partnership agreement can take the form of an oral or written agreement among the partners. In a partnership firm, the unanimous consent of all partners is necessary, and a partner cannot transfer their shares to a third party without the consent of the other partners. Trust and good faith among the partners are foundational principles upon which partnership businesses rely.

Advantages of Partnership firm

• Partnership business can be easily formed as it is a contractual agreement between the partners. Legal formalities are not that much and it can be easily formed through registration.
• Management in a partnership firm is well managed. As all the partners take interests in the affairs of the business because of earning the profit.
• The Risk in a partnership firm is minimum as it is shared by every partner of the firm. Every partner bear risk individually.
• Due to more number of persons in a business, there is a large number of resources for the business.

Disadvantages of partnership firm

• Partnership firm is always on a risk of loss of a partner. It does not exist for a long period of time. The death, insolvency of a partner can lead to the dissolution of a firm.
• A wrong decision of one partner can lead to the loss of every other partner. So while working in a partnership firm, the wrong decision should be avoided at any costs.
• Situations can occur where one partner does not agree with other partners. As in partnership firm, every partner has equal rights. This can cause a difficult situation for the business and mistrust can occur among the partners.
• Partnership business has unlimited liability and anyone can be asked to pay off the debt even with his personal properties.

Dissolution of partnership firm

• Section 39 of the Indian Partnership Act, 1932, provides the definition of the dissolution of a partnership firm. It states that when the partnership is dissolved among all the partners of a firm, it is referred to as the dissolution of the firm as a whole.
• It is important to differentiate between the dissolution of a partnership firm and the dissolution of individual partners. The dissolution of the firm entails the cessation of all business activities within the firm. When business operations come to a halt, and the assets are used to settle debts, it signifies the dissolution of the firm. On the other hand, when one partner agrees to continue the same firm even after another partner's retirement, it is considered a dissolution of partners rather than the firm. In this scenario, the firm continues to exist, but the partnership between the partners involved is terminated.
• Dissolving the firm also results in the dissolution of the partnership. Since there is a contractual relationship among the partners that operates within the framework of the firm, the dissolution of the firm automatically leads to the dissolution of the partnership.
• The Indian Partnership Act, 1932, elaborates on dissolution using various sections, from 40 to 44.
• Dissolution of a partnership firm can occur in two primary ways:
  • Dissolution without the intervention of the court (sections 40-43)
  • Dissolution by the Court (Section 44)

Dissolution without the Intervention of the court (Section 40-43)

Section 40 – Dissolution by agreement

A firm may be dissolved with the consent of all the partners or in accordance with a contract between the partners. The firm may be dissolved by the consent of all the partners or by entering into an agreement to dissolve the firm. This is one of the simple methods of dissolution of partnership firm and intervention of the court is not required in this.

Section 41-Compulsory Dissolution

A firm may be dissolved by the following points:

• Insolvency of partner: In case all the partners become insolvent or all the partners except one partner become insolvent then firm may be dissolved.
• Unlawful business: In case any unlawful activities are happening in the business of the firm to be carried on or for the partners to carry it on in partnership, the firm may be dissolved. Unlawful activities like selling of drugs, trading with alien countries, dealing in illegal products etc.
• For example, A, a resident of India and B a resident of China are partners. If war breaks out between the two countries then the partnership will become unlawful and hence it is dissolved automatically.

Section 42 – Dissolution on the happening of certain contingencies

This section focuses on the dissolution of the firm on happening of certain events. Dissolution of the firm can take place if the following events take place:

• Expiry of fixed term: If the contract of a partnership firm is on a fixed term. Then, dissolution of that firm will take place on the expiry of that contract. when the contract expires dissolution will take place.
• If the firm was formed for a certain number of task. Then on completion of that task, the firm ceases to exist. If the firm is constituted for a particular task then on completion of that task firm will dissolve, unless there is a contract or agreement.
• Dissolution can also take place with the death of a partner. Dissolution of the firm can take place only when the other partner chooses too. If he wants to continue the firm even after the death of a partner then there will be no dissolution of the firm. Only the partnership will be dissolved.
• When one of the partners or all the partners is insolvent then dissolution can take place. Even the insolvency of one partner can dissolve the firm.
• Dissolution can also take place if any one of the partners resigns. If one partner thinks not to continue further then he/she can resign but this will also dissolve the firm.

Section 43 – Dissolution by notice of partnership at will

Partner in a partnership firm can dissolve it by giving notice of dissolution to other partners. The notice should be communicated to the other partners as mentioned in the agreement and if not mentioned then a mode of communication should be reasonable. The notice of dissolution should not be in between any transaction and is a partner give notice of dissolution in between the transaction his notice should be held until the time the transaction is completed. The notice should be clear and should not be confusing in any sense. It should be properly communicated to the other partners.

Dhulia-Amalner Motor Transport … vs Raychand Rupsi Dharamsi And Ors. section 43 is explained in 3 points. It requires three things: (1) the giving of a notice, (2) the notice has to be in writing, and (3) the notice must express an intention to dissolve the firm. Unless these 3 things are complied with, the provision of section 43 of the Act would not come into operation at all.

Section 44 – Dissolution By the court

Dissolution of a firm can be done by suing the other partner and bringing the case before the court. The court may dissolve a firm on any of the following grounds:

• When one of the partners becomes of unsound mind and is unable to continue further than in this case a suit may be brought up by the other partner to dissolve the firm. Unsoundness of a partner does not automatically dissolve the firm but it can be a ground for dissolution. It is not necessary that the unsoundness should be permanent.
• If a partner has become permanently incapable of performing his duties as a partner then another partner can sue for dissolution of the firm. The Court may order for dissolution of the firm. Incapable to perform his duties can be due to any reason like going abroad for long time or imprisonment of a partner for a long time. As a partner won’t be able to perform his duties, the court will order for dissolution of the firm.
• If there is any misconduct by a partner other than the suing partner due to which firm has suffered loss, then the court may order the dissolution of the firm. Misconduct or guilty of conduct which is likely to affect prejudicially the carrying on of the business. Then the other partner can sue the partner for misconduct which is the ground for dissolution of the firm.
• Agreements are the most important document that all the partners must follow. If any partner breaches the agreement regarding the conduct of business then the other partner can sue him for breach of an agreement which is a ground of dissolution. The court may order for dissolution of a firm if a partner is found guilty of constant breach of the agreement and it becomes impossible to continue the business.
• When a partner transfers whole of his share/interests to the third party for permanently then it can be a ground for dissolution of firm or has allowed his share to be charged under the provisions of rule 49 of Order XXI of the First Schedule to the Code of Civil Procedure, 1908 (5 of 1908) or has allowed it to be sold in the recovery of arrears of land revenue or of any dues recoverable as arrears of land revenue due by the partner.
• If the firm is suffering from continuous loss, then the court may order for dissolution if there is no capital available for further growth.

Section 45-Liability of partners after dissolution

Section 45 defines liability for acts of partners done after dissolution. The partner, in this case, continue to be liable as such to the third parties for any act done before the dissolution. Liability of a partner does not finish automatically, the liability of a partner finishes when all the event are finished that has been taken up before the dissolution of the firm until public notice is given of the dissolution. A Partner who dies or who is adjudicated an insolvent or a partner who retires from the firm is not liable under this section for acts done after the date on which he ceases to be a partner. Notice of dissolution can be given by any partner.

Section 46 – Rights of partners to have business wound up after dissolution

After the dissolution of the firm, every partner is entitled to equal rights or according to the contract. All the partners are entitled to the property of the firm applied in payment of the debts and liabilities of the firm and to have the surplus distributed among the partners or their representatives according to their rights. These rights are given when winding up of the firm is taking place.

Section 47 – Continuing Authority of partners for purposes of winding up

After the dissolution of the firm the authority of each partner to bind the firm continues so far as for being necessary to wind up the affairs of the firm and to complete the transactions begun but unfinished at the time of dissolution. This section focuses on the transactions that are unfinished until the time of dissolution. Partners have to finish all the transactions that are related to a 3rd party for the purpose of winding up the business. It also states that firm is not bound by the acts of a partner who has been adjudicated insolvent but this provision does not affect the liability of any person who has after the adjudication represented himself as a partner of the insolvent.

Section 48- Mode of settlement of accounts between partners

This section defines all the modes in which the accounts can be settled among partners after dissolution.

The following rules shall be observed subject to agreement by the partners:

• All the losses of the company including deficiencies of capital shall be paid out of profits first, then out of the capital and lastly if necessary by the partners individually in proportions to which they are entitled to share profits.
• All the assets of the company including all the sums contributed by the partners shall be applied in the following manner:
• In paying all the debts of the firm to the third parties
• in paying each partner rateable what is due to him from the firm for advances as distinguished from capital
• in paying to each partner rateable what is due to him on account of capital
• The residue shall be divided among the partners in the proportions in which they were entitled to share profits.

Section 49- Payment of firm debts and of separate debts.

• Payment of Joint debts and separate debts due form any partner is explained in this section.
• The property/assets of the firm shall be applied first in payment of the debt of the firm and if there is any surplus then of each partner shall be applied in payment of his separate debts or paid to him.
• The separate property of any partner shall be applied first to the payment of his separate debts and then the surplus in the payment of the debts of the firm.

Section 50 – Personal profits earned after dissolution

The provision of clause (a) of section 16(Personal profits earned by partners) shall apply to the transactions by surviving partner or by the representative of a deceased partner after the firm is dissolved on account of the death of a partner and before its affairs have been completely wound up.

Section 51 – Return of premium o premature dissolution

Where a partner paid a premium on entering into partnership and the firm is dissolved before the expiration of that term due to death of a partner, then he shall be entitled to repayment of the premium or of a part as may be reasonable. The term upon which he became a partner and to the length of time during which he was a partner such part will be repaid as may be reasonable except the dissolution is mainly due to his own misconduct the dissolution is in pursuance an agreement containing no provision for the return of the premium or any part of it.

Conclusion

In Indian Partnership Act, 1932 provisions are given by which a partnership firm can be dissolved before the court or outside the court. The grounds on which dissolution of firm takes place is written clearly in the act. The act is to make things clear and just in a partnership firm so that partners do not take advantage of each other. Act also help us to maintain a stable environment in the firm.