Nature of Partnership | Law of Contracts - CLAT PG PDF Download

 NATURE OF A PARTNERSHIP FIRM 

A partnership firm is viewed differently by the law. It is not considered a separate legal person, except in specific cases like the Income Tax Act. This means that the firm itself cannot enter into contracts; only the individual partners can.

For instance, if two partnership firms, M/s A&B and M/s X&Y, wanted to form a new partnership, they couldn't do so as firms. However, the individual partners from each firm could come together to create a new partnership.

 Definition of Partnership 

Partnership is a business model where two or more individuals combine their resources to invest in a shared business with the goal of dividing the profits among themselves.

 Advantages Over Sole Proprietorship 

Partnership addresses the limitations faced by sole proprietors, such as:

•  Limited Capital:  Partnerships can pool resources from multiple partners, increasing the available capital for the business.
•  Risk Sharing:  Risks are distributed among partners, reducing the burden on a single individual.
•  Diverse Skills:  Partners can bring different skills and expertise to the business, enhancing its overall capability.

In essence, partnerships offer a way for individuals to collaborate and start a business while sharing the responsibilities and benefits.

 Test of Partnership (Section 6) 

According to Section 6 of the Indian Partnership Act, the determination of whether a group of persons constitutes a firm relies on the real relationship between the parties, as evidenced by all relevant facts considered together.

 Determining the Real Relationship 

•  Express Contract:  If there is an express partnership contract, the real relationship is determined from the terms outlined in the contract.
•  No Express Contract:  In the absence of an express contract, the real relationship is ascertained from various relevant factors such as the conduct of the parties, books of accounts, and statements of employees.

 Principles from Legal Precedent 

• Section 6 is rooted in the legal principle established in the case of  Cox v. Hickman (1860)  .
• The true test of partnership, as per this section, involves:
•  Real Relationship:  Partnership is determined by the real relationship between partners, which must demonstrate the existence of a mutual agency relationship.
•  Profit Sharing:  While sharing profits is evidence of partnership, it is not conclusive on its own.

 Essential Elements of Partnership 

• A group of individuals is considered a partnership if the real relationship between them indicates the presence of all essential elements of partnership.

 Cases Where Partnership Does Not Exist 

•  Explanation I to Section 6:  Joint owners of property sharing profits or gross returns from the property do not constitute a partnership.
•  Example:  If X and Y jointly purchase a building, convert it into a hotel, and share the rental income equally, they are considered co-owners, not partners, because there is no mutual agency relationship.
•  Leading Case: Govind Nair v. Maga.

 Explanation II to Section 6 

• Persons sharing profits without a mutual agency relationship are not partners, despite sharing profits.
•  Money Lender:  A money lender who receives a share of profits as part of the loan agreement is not a partner. (Cases:Mallow Mantle & Co. v. The Court of WardsandCox v. Hickman)
•  Widow or Child of Deceased Partner:  The widow or child of a deceased partner sharing profits does not become a partner merely by sharing profits. (Case:Holme v. Hammond)
•  I.T. Commissioner v. Kesharmal Keshardeo:  There is no restriction on the widow or son of a deceased partner joining the firm after the partner's death, as per the agreement terms.
•  Servant or Agent:  A servant or agent receiving a share of profits as part of their remuneration does not become a partner. (Cases:Munshi Abdul Latif v. GopeshwarandWalker v. Hrisch)
•  Seller of Goodwill:  A seller of goodwill sharing profits as consideration for the sale of goodwill does not become a partner. (Cases:Rawlinson v. ClarkeandPratt v. Strick)

[Question: 1754325]

Who Are Not Considered Partners?

In certain situations, individuals may not be regarded as partners in a business venture. The following categories of persons are typically excluded from the definition of partners:

 Members of a Hindu Undivided Family (HUF) 

• When members of a Hindu undivided family (HUF) are engaged in carrying on a family business, they are not treated as partners in the traditional sense.

 Burmese Buddhist Husband and Wife 

• Similarly, a Burmese Buddhist husband and wife operating a business together are also not considered partners under the legal framework.

Despite these exceptions, a partnership can still be presumed to exist under certain conditions:

 Presumption of Partnership 

•  Agreement to Share Profits:  A partnership is presumed when there is an agreement to share the profits of a business.
•  Business Conducted by All or Some:  The business must be carried on by all partners or by any of them acting on behalf of all.

Even in cases where one partner has exclusive power and control over the business as per an agreement, a partnership is still presumed to exist. This principle was highlighted in the case of  K.D. Kamath & Co. v. Commissioner of Income Tax. 

 Partnership and Co-Ownership 

Co-ownership refers to the joint ownership of a property by two or more individuals. These individuals are known as co-owners. According to Explanation I of Section 6, joint owners who share the profits or gross returns from a property do not automatically become partners.

 Key Differences between Partnership and Hindu Undivided Family (HUF) 

 Partnership 

• Originates from an agreement.
• Governed by the Indian Partnership Act, 1932.
• Individuals forming the partnership are termed 'Partners.'
• Maximum partners allowed are 10 for banking businesses and 20 for other types of businesses.
• A new partner can join an existing partnership with the consent of all current partners.
• A minor can be included in the partnership benefits with the agreement of all partners.
• Females can be full-fledged partners.
• Each partner has the authority to bind the firm through actions taken in the regular course of business.
• All partners share unlimited liability.
• Partners have the right to inspect and copy financial records and request profit and loss accounts.
• Partnership is dissolved upon the death of any partner unless otherwise agreed.

 Hindu Undivided Family (HUF) 

• Established by status or legal operation.
• Regulated by Hindu Law.
• Members of the HUF are known as 'Coparceners.'
• No limit on the number of coparceners.
• A male becomes a member by birth.
• A male minor becomes a member by birth.
• A female does not automatically become a member by birth.
• Only the Karta has implied authority.
• The Karta has unlimited liability, while other coparceners' liability is limited to their shares in the family property.
• Coparceners cannot demand accounts of past transactions.
• The HUF continues to function even after the death of a coparcener.

Partnership vs Company 

 Partnership 

• A partnership is a legal arrangement where two or more individuals come together to conduct business.
• In a partnership, the partners are collectively known as a firm, and they do not have separate legal existence from the firm.
• The liability of partners in a partnership is unlimited, meaning they are personally responsible for the debts and obligations of the business.
• Partnerships do not have a long lease of life, as they can be dissolved due to the death, illness, or retirement of a partner.
• The minimum number of partners required to form a partnership is two. The maximum number of partners can be ten in the case of banking businesses and twenty in the case of non-banking businesses.
• Partners cannot transfer their shares or interests in the partnership without the consent of the other partners.
• Each partner represents the other partners, binding and being bound by the actions of the others.
• Profits in a partnership are distributed among partners according to the terms outlined in the partnership deed.
• All partners share the management of the partnership equally.
• The property of the firm is considered the joint property of all its partners.

 Company 

• A company is a legal entity created by law, distinct from its members. It has a separate legal existence, meaning it can own property, enter into contracts, and sue or be sued in its own name.
• Members of a company have limited liability, meaning their financial responsibility is limited to the value of the shares they hold.
• Companies enjoy perpetual existence, meaning they can continue to exist even if all their members die or leave.
• A public company must have a minimum of seven members to start, with no maximum limit on the number of members. A private company requires a minimum of two members and a maximum of 200.
• Members of a company can freely transfer their shares without restrictions.
• There is no agency relationship among members of a company, meaning their actions do not bind each other.
• Companies are not obligated to distribute profits; dividends are only paid when declared. Members cannot participate in management unless appointed as directors, but they can attend and vote at meetings.
• The property of the company is separate from the property of its members, as the company and its members have distinct legal identities.

DURATION OF PARTNERSHIP

Partnership can be classified based on duration into two types:  1) Partnership at Will  and  2) Particular Partnership  .

 Partnership at Will (Section 7) 

• When the partnership agreement does not specify a duration, it is called a  Partnership at Will  .
• Any partner can dissolve the partnership by giving written notice to all other partners.

 Particular Partnership (Section 8) 

• A  Particular Partnership  is formed for a specific venture or a set period.
• It ends upon the completion of the venture or the expiry of the period.
• If the partnership continues beyond the specified term or completion of the venture, it becomes a Partnership at Will.
• A Particular Partnership can be dissolved before the term or completion only with the mutual consent of all partners.

[Question: 1754327]

Types of Partners 

•  Actual or Ostensible Partner:  Actively involved in the business, liable for all acts, and must give public notice of retirement.
•  Sleeping or Dormant Partner:  Not involved in daily operations, still liable for acts, and does not need to give public notice of retirement.
•  Nominal Partner:  Lends name to the firm without real interest, liable for acts, and must give public notice of retirement.
•  Partner in Profits Only:  Shares profits but not losses.
•  Sub Partner:  Shares profits with a partner but has no rights or liabilities with the firm.

Partner by Estoppel or Holding Out [Section 28(1)]

• A person can be considered a partner by estoppel or holding out if the following two conditions are met:
•  Active Representation:  The person must have represented themselves as a partner, either through spoken or written words or by their conduct. This is known as active representation.
•  Tacit Representation:  Alternatively, the person may have knowingly allowed themselves to be represented as a partner, which is called tacit representation.
• The other party, relying on this representation, must have extended credit to the firm. It does not matter whether the person making the representation is aware that it has reached the other party.

 Example: 

• Harish, the sole proprietor of Harish Shirish& Co., hired Shirish as a manager.
• Harish introduced Shirish as his partner to X, a supplier of goods.
• Shirish did not correct this impression.
• Believing Shirish was a partner, X supplied goods on credit.
• When Harish failed to pay for the goods, X sued both Harish and Shirish for the payment.
• In this case, Shirish is considered liable as a partner by holding out because he allowed himself to be represented as a partner, and the supplier acted based on this representation.

 Position of a Retiring Partner as Partner by Holding Out [Section 28(2)] 

• When a partner retires from a firm, if the firm continues to use the retired partner's name as if they are still a partner, the retired partner can be held liable on the basis of holding out to third parties.
• This applies especially if the retired partner did not give public notice of their retirement.
• Third parties who extend credit to the firm under the belief that the retired partner is still a member can hold the retired partner accountable.