ICAI Notes 3.1 - Basics of Partnership - CA Foundation PDF Download

Learning Objectives

• Understand the concept of partnerships and be clear about its essentials.
• Try to understand the ‘principal - agent relationship’ among the partners.
• Note the points of difference between partnership and other various forms of organisation.
• Be aware of the position of a minor in a partnership.

3.1 WHAT IS PARTNERSHIP?

Partnership is the relation between persons who have agreed to share the profits of a business carried on by all or any one of them acting for all (Section 4). It, therefore, follows that a partnership consists of three essential elements :
(i) It must be a result of an agreement between two or more persons.
(ii) The agreement must be to share the profits of the business.
(iii) The business must be carried on by all or any of them acting for all. All these essentials must coexist before a partnership can come into existence.

3.2 ESSENTIAL ELEMENTS OF PARTNERSHIP

We shall now consider the afore stated essential elements one by one.

Agreement : You have just observed that partnership must be the result of an agreement between two or more persons. You should note that it can arise only from a contract and not from status. That is why, a partnership is distinguishable from a Hindu Undivided Family carrying on a family business. The reason is that as a result of the peculiarities of the Mitakshara School of Hindu Law applicable to joint families, a male child of a Hindu acquires an interest in a family business even in the absence of an agreement in that behalf, whereas partnership is a creation only of mutual agreement. Thus the nature of the partnership is voluntary and contractual.

An agreement from which relationship of Partnership arises may be express. It may also be implied from the act done by partners and from a consistent course of conduct being followed, showing mutual understanding between them. It may be oral or in writing.

Sharing profit of business : In this context, we will consider two propositions. First, there must exist a business. For the purpose, the term ‘business’ includes every trade, occupation and profession. The existence of business is essential. The motive of the business is the “acquisition of gains” which leads to the formation of partnership. Therefore there can be no partnership where there is no intention to carry on the business and to share the profit thereof.

For example, co-owners who share amongst themselves the rent derived from a piece of land are not partners, because there does not exist any business. Similarly, no charitable institution or club may be floated in partnership [A joint stock company may, however, be floated for non-economic purposes]. Secondly, there must be an agreement to share profits. For example X and Y buy certain bales of cotton which they agree to sell on their joint account and to share the profits equally. In these circumstances, X and Y are partners in respect of such cotton. But an agreement to share losses is not an essential element. However, in the event of losses, unless agreed otherwise, these must be borne in the profit-sharing ratio.

Business carried on by all or any of them acting for all : The third requirement is that the business must be carried on by all the partners or by anyone or more of the partners acting for all. This is the cardinal principle of the partnership Law. An act of one partner in the course of the business of the firm is in fact an act of all partners. Each partner carrying on the business is the principal as well as the agent for all the other partners. You should, therefore, note that the true test of partnership is mutual agency rather than sharing of profits. If the element of mutual agency is absent then there will be no partnership. Sharing of profits is only Prima facie evidence which can be rebutted by a stronger evidence. Thus, this prima facie evidence can be rebutted by proving that there is no mutual agency.

3.3 TRUE TEST OF PARTNERSHIP

You must have understood that sharing of profit is an essential element to constitute a partnership. But, it is only a prima facie evidence and not conclusive evidence, in that regard. The sharing of profits or of gross returns accruing from property by persons holding joint or common interest in the property would not by itself make such persons partners. Although the right to participate in profits is a strong test of partnership, and there may be cases where, upon a simple participation in profits, there is a partnership, yet whether the relation does or does not exist must depend upon the whole contract between the parties.

Where there is an express agreement between partners to share the profit of a business and the business is being carried on by all or any of them acting for all, there will be no difficulty in the light of provisions of Section 4, in determining the existence or otherwise of partnership. But the task becomes difficult when either there is no specific agreement or the agreement is such as does not specifically speak of partnership. In such a case for testing the existence or otherwise of partnership relation, Section 6 has to be referred. According to Section 6, regard must be had to the real relation between the parties as shown by all relevant facts taken together. The rule is easily stated and it is clear but its application is difficult. Cumulative effect of all relevant facts such as written or verbal agreement, real intention and conduct of the parties, other surrounding circumstances etc., are to be considered while determining the relationship between the parties and ascertaining the existence of partnership.

The receipt by a person of a share of the profits of a business or a payment contingent upon the earning of profits or varying with the profits earned by business, would not by itself make him a partner with the persons carrying on the business, particularly, when such share of payment is received by the following persons
(i) a lender of money to persons engaged or about to the engaged in any business, or
(ii) a servant (e.g., manager of a firm) or agent as his remuneration, or
(iii) widow or child of a deceased partner or
(iv) A previous owner of part of the business as the consideration for the sale of the goodwill or share thereof. 

Existence of Mutual Agency which is the cardinal principle of partnership law, is very much helpful in reaching a conclusion in this regard. Each partner carrying on the business is the principal as well as an agent of other partners. So, the act of one partner done on behalf of firm, binds all the partners. If the element of mutual agency relationship exists between the parties constituting a group formed with a view to earn profits by running a business, a partnership may deemed to be existed. Distinction between partnership and firm : Persons who have entered into partnership with one another are called individual “Partners” and “collectively” and the name under which the business is carried on is called the “firm name”. Partnership is merely an abstract legal relation between the partners. A firm is a concrete thing signifying the collective entity for all the partners. Partnership is thus that invisibility which binds the partners together and firm is the visible form of those partners who are thus bound together.

3.4 PARTNERSHIP DISTINGUISHED FROM OTHER FORMS OF ORGANISATION

3.4.1 PARTNERSHIP VS. JOINT STOCK COMPANY

(1) Personality : A firm is not legal entity i.e., it has no legal personality distinct from the personalities of its constituent members. On the other hand, a registered company is a judicial person distinct from its members.

(2) Agency : In a firm, every partner is an agent of the other partners, as well as of the firm, but in the case of a company a member is not an agent of the other members or of the company, his actions do not bind either.

(3) Distribution of profits : The profits of the firm must be distributed among the partners according to the terms of the partnership deed. But in the case of a company, there is no such compulsion to distribute its profits among its members. Some portion of the profits, but generally not the entire profit, become distributable among the shareholders only when dividends are declared.

(4) Extent of liability : In a partnership, the liability of the partners is unlimited. This means that each partner is liable for debts of a firm incurred in the course of the business of the firm and these debts can be recovered from his private property, if the joint estate is insufficient to meet them wholly. On the other hand, the liability of a shareholder is limited to the amount, if any, unpaid on his shares, in the case of company limited by shares; but in the case of a guarantee company, the liability is limited to the amount for which he has agreed to be liable. However, there may be companies where the liability of members is unlimited.

(5) Property : The firm’s property is that which is the “joint estate” of all the partners as distinguished from the ‘separate’ estate of any of them and it does not belong to a body distinct in law from its members. That is why, in the event of insolvency, the joint estate, after meeting the liability in respect of joint debts devolves on the partners. But in the case of a company, its property is separate from that of its members who can receive it back only in the form of dividends or refund of capital.

(6) Transfer of shares : A share in a partnership cannot be transferred without the consent of all the partners; but in a company, a shareholder may transfer his shares, subject to the provisions contained in its Articles. In the case of public limited companies whose shares are quoted on the stock exchange, the transfer is usually unrestricted.

(7) Management : In the absence of an express agreement to the contrary, all the partners are entitled to participate in the management. But members of a company are not entitled to take part in the management unless they are appointed as directors, in which case they may participate. Members, however, enjoy the right of attending general meeting and voting there at to decide certain questions such as election of directors, appointment of auditors, etc.

(8) Number of membership : In the case of firms carrying on business other than banking, the number must not exceed 20 and in the case of banks such number must not exceed  10. A private company may have as many as 50 members but not less than two and a public company may have any number of members but not less than seven.

3.4.2 PARTNERSHIP VS. CLUB
A club is an association of persons formed with the object not of earning profit, but of promoting some beneficial purposes such as improvement of health or providing recreation for the members, etc. On the other hand, partnership is also an association of persons but formed with the object of earning profit.

(1) Unlike a partner, a member of a club is not the agent of other members nor is he liable to a creditor of the club, except when he is responsible for the contract which gave rise to the liability.

(2) A member of a club has no interest in the property of the club, as a partner has in the property of the firm. Also, the change in the membership of a club does not affect its existence.

3.4.3 PARTNERSHIP VS. HINDU UNDIVIDED FAMILY 

(1) Creation : The relation of partnership is created necessarily by an agreement, whereas the right in the joint family is created by status. The creation of a right by status means its creation by birth in the family.

(2) Death : Death of a partner ordinarily leads to the dissolution of partnership. But the death of a member in the Hindu undivided family does not give rise to dissolution of the family business.

(3) Management : The right of management of joint family business generally vests in the Karta, the governing male member of the family. But in the case of a partnership, all the partners are equally entitled to take part in the partnership business.

(4) Authority to bind the firm : In the joint family, the Karta or the manager, has the authority to contract for the family business. In partnership, every partner can, by his act, bind the firm.

(5) Liability : In a partnership, the liability of a partner is unlimited; but in a Hindu undivided family, only the liability of the Karta is unlimited, and the other copartners are liable only to the extent of their share in the profits of the family business, unless they take part in the act performed or transactions entered into by the Karta.

(6) Calling for accounts : On the separation of the joint family, a member is not entitled to ask for account of the family business. But a partner can bring a suit against the firm for accounts, provided he also seeks the dissolution of the firm.

(7) Governing Law : A partnership is governed by the Partnership Act; a Joint Hindu family business is governed by the Hindu Law.

(8) Minor’s capacity : In a partnership, a minor cannot become a partner, though he can be admitted to the benefits of partnership, only with the consent of all the partners. In Hindu undivided family business, a minor becomes a member of the ancestral business by the incidence of birth. He does not have to wait for attaining majority.

(9) Continuity : A Joint Hindu Family has the continuity till it is divided. The status of Joint Hindu Family is not thereby affected by the death of a member, but a firm subject to a contract between the partners gets dissolved by death or insolvency of a partner.

3.4.4 PARTNERSHIP VS. CO-OWNERSHIP 

(1) Partnership always arises out of a contract, express or implied co-ownership may arise either from agreement or by the operation of law, such as by inheritance.
(2) In partnership, there is community of interest. It means that profits and losses must have to be shared but co-ownership does not necessarily involve sharing of profits and losses.
(3) In the case of partnership, a partner is the agent of the other partners, but in the case of a co-ownership, a co-owner is not the agent of other co-owners.
(4) A share in the partnership is transferred only by the consent of other partners. Co-ownership may be dissolved at the will of co-owners; also a co-owner may transfer his interest or rights in the property without the consent of other co-owners.

3.4.5 PARTNERSHIP VS. ASSOCIATION 

(1) Partnership means and involves setting up relation of agency between two or more persons who have entered into a business for gains, with the intention to share the profits of such a business; but partnerships does not exist between members of a charitable society or religious association or an improvement scheme or building corporation, etc.
(2) Partnership does not exist between members of a mutual insurance society.
(3) In a trade combine or protection association, the relation between the members is not that of partnership.

3.5 TYPES OF PARTNERS 

Active Partner means a person (i) who has become a partner by agreement and (ii) who actively participates in the conduct of the partnership. While a partner who does not take an active part in the conduct of the business of the firm is called a sleeping(dormant) partner. A person who lends his name to the firm, without having any real interest in it is called a nominal partner.

‘Partner’ by holding out’ (Section 28) : Partnership by ‘holding out’ is also known as partnership by estoppel. Where a man holds himself out as a partner, or allows others to do it, he is then stopped from denying the character he has assumed and upon the faith of which creditors may be presumed to have acted. When a person (i) represents himself, or (ii) knowingly permits himself, to be represented as a partner in a firm (when in fact he is not) he is liable, like a partner in the firm to anyone who on the faith of such representation has given credit to the firm.

A person may himself, by his words or conduct have induced others to believe that he is a partner or he may have allowed others to represent him as a partner. The result in both the cases is identical.

Example: X and Y are partners in a partnership firm. X introduced A, a manger, as his partner to Z. A remained silent. Z, a trader believing A as partner supplied 100 T.V sets to the firm on credit. After expiry of credit period, Z did not get amount of T.V sets sold to the partnership firm. Z filed a suit against X and A for the recovery of price. Considering the provisions of the Indian Partnership Act, 1932 state whether A is liable.

Yes, A is also liable for the price because he becomes a partner by holding out (Section 28, Indian Partnership Act, 1932). It is only the person to whom the representation has been made and who has acted thereon that has right to enforce liability arising out of ‘holding out’.

You must also note that for the purpose of fixing liability on a person who has, by representation, led another to act, it is not necessary to show that he was actuated by a fraudulent intention. The rule enunciated in Section 28 is also applicable to a former partner who has retired from the firm without giving proper public notice of his retirement. In such cases a person who, even subsequent to the retirement, give credit to the firm on the belief that he was a partner, will be entitled to hold him liable.

Sub-partnership : A sub-partnership may arise when, consequent upon an agreement between a partner in a firm and a stranger, the latter is vested with interest jointly with that partner so far as his share in the firm is concerned.

Such an agreement will not render the stranger a partner of the main firm. A sub-partner can claim the agreed share from the actual partner, but he can have no right against the main firm to take part in or to interfere with its business or to examine its account.

3.6 MINOR’S POSITION IN PARTNERSHIP 

We shall now discuss a topic, viz., minor’s position in relation to partnership. You will recall that a minor cannot be bound by a contract because a minor’s contract is void and not merely voidable. Therefore, a minor cannot become a partner in a firm because partnership is founded on a contract. Though a minor cannot be a partner in a firm, he can nonetheless be admitted to the benefits of partnership under Section 30 of the Act. In other words, he can be validly given a share in the partnership profits. When this has been done and it can be done with the consent of all the partners then the rights and liabilities of such a partner will be governed under Section 30 as follows :

(1) Rights :

(i) A minor partner has a right to his agreed share of the profits of the firm.
(ii) He can have access to, inspect and copy the accounts of the firm.
(iii) He can sue the partners for accounts or for payment of his share but only when severing his connection with the firm, and not otherwise.
(iv) On attaining majority he may within 6 months elect to become a partner or not to become a partner. If he elects to become a partner, then he is entitled to the share to which he was entitled as a minor. If he does not, then his share is not liable for any acts of the firm after the date of the public notice served to that effect.

(2) Liabilities :

(i) The minor’s share is liable for the acts of the firm, but he is not personally liable for any such act. (ii) Within 6 months of his attaining majority or on his obtaining knowledge that he had been admitted to the benefits of partnership, whichever date is later, he may give public notice that he has elected not to become partner and such notice shall determine his position as regards the firm. If he fails to give such notice he shall become a partner in the firm on the expiry of the said six months. If the minor becomes a partner of his own willingness or by his failure to give the public notice within specified time, the position will be as follows :

(i) He becomes personally liable to third parties for all acts of the firm done since he was admitted to the benefits of partnership.
(ii) His share in the property and the profits of the firm remains the same to which he was entitled as a minor.

Where the minor decides to sever his connection with the firm his rights and liabilities will be as follows.

(i) His rights and liabilities continue to be those of a minor up to the date of giving public notice. (ii) His share shall not be liable for any acts of the firm done after the date of the notice.
(iii) He shall be entitled to sue the partners for his share of the property and profits. It may be noted that such minor shall give notice to the Registrar that he has or has not become a partner.

3.7 SUMMARY 

It is not quite easy to define the term ‘Partnership’. The definition given by Section 4 of the Act brings out very clearly the fundamental principle that each partner, when carrying on the business of the firm, is an agent as well as principal, and is probably the most business like definition of the term. The definition contains three elements which must be present before a group of persons can be held to be partners, namely;
(a) agreement among all the partners;
(b) agreement to share the profits of the business;
(c) the business must be carried on by all or any of them, acting for all. These three elements may appear to overlap, but they are nevertheless distinct.

The element of agreement in partnership distinguishes it from various other relations which arise by operation of law and not from agreement, such as, joint-owners, Hindu Undivided Family, etc.