Unit 1: General Nature of Partnership Chapter Notes | Business Laws for CA Foundation PDF Download

Overview

Definition of 'Partnership', 'Partner', 'Firm', and 'Firm Name' (Section 4)

• Partnership: This refers to the relationship between individuals who have agreed to share the profits of a business conducted by all or any of them on behalf of everyone.
• Partner: Individuals who enter into a partnership with one another are called partners.
• Firm: The collective term for partners in a partnership.
• Firm Name: The name under which the business of the partnership is carried on.

Elements of Partnership

1. Association of Two or More Persons:

• Partnership involves an association of two or more persons.
• Only individuals recognized by law can enter into a partnership agreement. For instance, a firm itself cannot be a partner as it is not considered a legal person.
• A minor cannot be a partner in a firm, but with the consent of all existing partners, a minor may be admitted to the benefits of partnership.
• While the Partnership Act does not specify a maximum number of partners, the Companies Act, 2013 limits the number of partners in certain types of associations to 50.

2. Agreement:

• A partnership must result from an agreement between two or more individuals.
• There must be a mutual understanding and agreement among all parties involved.
• This element emphasizes the voluntary and contractual nature of partnerships. Partnerships are inherently based on mutual consent and contractual agreements.
• An agreement leading to a partnership can be explicit or implied based on the actions and consistent conduct of the partners indicating mutual understanding. It can be oral or written.

3. Business:

• There must be a business for the partnership to exist.
• The term "business" encompasses all forms of trade, occupation, and profession.
• The existence of a business is crucial, and the underlying motive of the business is the "acquisition of gains." This intention to carry on a business and share its profits is fundamental to the formation of a partnership.

4. Agreement to Share Profits:

• Sharing profits is a crucial aspect of any partnership. A partnership cannot exist if only one partner is entitled to all the profits. Partners must agree to share the profits in any way they choose.
• However, agreeing to share losses is not necessary for a partnership. One or more partners can agree to bear all the losses. Unless agreed otherwise, losses must be shared in the same ratio as profits.
• Example 1: Co-owners sharing rent from a piece of land are not partners because there is no business involved.
• Example 2: Charitable institutions can operate under partnership principles if they meet legal criteria, even though they may have different structural requirements.
• Example 3: If X and Y buy bales of cotton to sell jointly and share profits equally, they are partners in the cotton business.

5. Business Carried On by All or Any of Them Acting for All:

• The business must be conducted by all partners or by any one or more partners acting on behalf of all. This principle is fundamental to partnership law and implies a binding contract of mutual agency among partners.
• Any action taken by one partner during business operations is considered an action by all partners. Each partner is both a principal and an agent for the others. This means that a partner acting as an agent binds the other partners to their decisions, and as a principal, they are bound by the actions of other partners.
• It is important to note that mutual agency is the true test of partnership, not just profit sharing. Without mutual agency, there is no partnership.
• Example 4: In a partnership firm like ABC Associates, if one partner makes purchases for the business, all partners are liable for the actions taken on behalf of the firm.

KD Kamath & Co. v. CC
The Supreme Court has established two fundamental conditions that must be met for a partnership to exist:

1. There must be an agreement to share both the profits and the losses of the business.
2. The business must be conducted by all partners or any of them acting on behalf of all, as per the definition of 'partnership' in section 4 of the Partnership Act.

Furthermore, the court clarified that one partner could have exclusive power and control over the partnership by mutual agreement. For instance, if only one partner is authorized to operate bank accounts or borrow on behalf of the firm, it does not invalidate the partnership, as long as the two essential conditions are fulfilled.

Note:

The 'Partnership Agreement' is also referred to as the 'Partnership Deed.'

True Test of Partnership

Mode of Determining Existence of Partnership (Section 6): When assessing whether a group of individuals constitutes a partnership or whether someone is a partner in a firm, the real relationship between the parties must be considered based on all relevant facts taken together.

To establish the existence of a partnership, the following elements must be proven:

1. There was a mutual agreement among all parties involved.
2. The agreement was to share the profits of a business.
3. The business was conducted by all or any of the parties acting on behalf of all.

Agreement: Partnership is based on Agreement, Not Status (Section 5):

• Partnership arises from a contract and not from status. For example, members of a Hindu Undivided Family or a husband and wife in a Burmese Buddhist context running a family business are usually not considered partners.

Sharing of Profit:

• Sharing profits or gross returns from property does not automatically make individuals partners.
• Receiving a share of profits or a payment contingent on profits does not make someone a partner, such as:
• (a) A lender of money to a business,
• (b) A servant or agent receiving remuneration,
• (c) A widow or child of a deceased partner receiving an annuity,
• (d) A previous owner of a business receiving consideration for the sale of goodwill or a share.

Difficulty in Determining Partnership:

• The task of identifying a partnership becomes challenging when there is either no specific agreement or the agreement does not explicitly mention partnership. In such cases, Section 6 of the relevant legal framework must be referred to in order to assess the existence of a partnership relation.

Real Relation and Relevant Facts:

• According to Section 6, the focus should be on the real relation between the parties as indicated by all relevant facts taken together.
• While the rule is clear and straightforward, its application can be difficult.
• It is necessary to consider the cumulative effect of all relevant facts, including written or verbal agreements, the genuine intentions and conduct of the parties, and other pertinent factors, when determining the relationship between the parties and the existence of a partnership.

Sharing of Profits:

• Sharing of profits is a crucial element in constituting a partnership.
• However, it is only prima facie evidence and not conclusive evidence of a partnership.
• Simply sharing profits or gross returns from property among individuals with a joint or common interest does not automatically create a partnership.
• While the right to participate in profits is a strong indicator of partnership, the existence of the relationship depends on the overall contract between the parties.

Express Agreement and Agency:

• When there is an express agreement among partners to share the profits of a business, and the business is being carried out by all or any of them acting on behalf of the others, there should be no difficulty in determining the existence of a partnership in light of Section 4.
• The concept of mutual agency, which is fundamental to partnership law, is also helpful in reaching a conclusion about the existence of a partnership.
• Each partner carrying on the business is both a principal and an agent of the other partners, meaning that the actions of one partner on behalf of the firm bind all partners.
• If the elements of a mutual agency relationship are present among the parties forming a group to earn profits through a business, a partnership may be deemed to exist.

Santiranjan Das Gupta Vs. Dasiran Murzamull (Supreme Court)
In the case of Santiranjan Das Gupta Vs. Dasiran Murzamull, the Supreme Court concluded that there was no partnership between the parties involved due to several key factors:

• Lack of Documentation: The parties did not have any records outlining the terms and conditions of the purported partnership.
• Absence of Open Accounts: There were no partnership accounts maintained that were accessible for inspection by both parties.
• No Bank Account: No partnership account was opened with any bank.
• Failure to Notify Authorities: There was no written communication sent to the Deputy Director of Procurement regarding the establishment of the new partnership.

Partnership Distinguished from Other Forms of Organisation

Partnership Vs. Joint Stock Company

• Legal Status: A partnership firm does not have a distinct legal identity apart from its partners. It is not a separate legal entity.
• Agency: In a partnership, each partner acts as an agent for the other partners and for the firm as a whole.
• Profit Distribution: Profits in a partnership are distributed among partners according to the partnership agreement.
• Liability: Partners have unlimited liability, meaning they are personally responsible for the firm’s debts, which can be recovered from their personal assets.
• Property: The firm’s property is considered joint property of all partners and does not belong to a separate legal entity.
• Share Transfer: Partners cannot transfer their share in the partnership without the consent of all other partners.
• Management: All partners have the right to participate in the management of the firm unless otherwise agreed.

Joint Stock Company:

• Legal Status: A joint stock company is a separate legal entity distinct from its members, as established in the case of Salomon v. Salomon.
• Agency: In a company, a member is not an agent for other members or the company, and their actions do not bind others.
• Profit Distribution: A company is not required to distribute its profits among members. Profits become distributable only when dividends are declared.
• Liability: In a company limited by shares, a shareholder’s liability is limited to the amount unpaid on their shares. In a guarantee company, liability is limited to the agreed amount.
• Property: A company’s property is separate from that of its members. Members can receive property back only in the form of dividends or capital refunds.
• Share Transfer: Shareholders can transfer their shares in a company, subject to the company’s Articles. In public limited companies, share transfer is usually unrestricted.
• Management: Members of a company cannot participate in management unless appointed as directors. Members have the right to attend general meetings and vote on certain matters, such as electing directors and appointing auditors.

Registration

• Partnership: Registration is not mandatory for partnerships.
• Company: A company cannot legally exist without being registered under the Companies Act, 2013.

Winding Up

• Partnership: A partnership firm can be dissolved at any time if all partners agree to it.
• Company: A company is a legal entity and can only be wound up by the National Company Law Tribunal or have its name struck off by the Registrar of Companies.

Number of Members

• Partnership: According to the Companies Act, 2013, the number of partners in a partnership should not exceed 100. However, the Companies (Miscellaneous) Rules, 2014, limits this number to 50.
• Company: A private company can have up to 200 members, but not less than two. A public company can have any number of members, but at least seven. A private company can also be formed by a single individual, known as a one-person company.

Duration of Existence

• Partnership: Unless otherwise agreed, the death, retirement, or insolvency of a partner leads to the dissolution of the firm.
• Company: A company enjoys perpetual succession, meaning it continues to exist regardless of changes in ownership or the death of shareholders.

Partnership Vs. Club

• Partnership: A partnership is a group of people coming together to make a profit from a business that any one of them can run on behalf of all.
• Club: A club is formed for non-profit reasons, like improving health or providing recreation, not for making money.

Relationship:

• Partnership: In a partnership, the people involved are called partners, and each partner acts as an agent for the others.
• Club: In a club, the members are called members, and one member does not act on behalf of the others.

Interest in the Property:

• Partnership: A partner has a stake in the firm’s property.
• Club: A club member usually doesn’t own rights to club property like partners do, but they may have some rights to use it.

Dissolution:

• Partnership: Changing the partners in a firm can change its existence.
• Club: Changing the members of a club does not affect its existence.

Partnership vs. Hindu Undivided Family

• Partnership is formed through an agreement.
• In a Joint Hindu Family, rights are inherited by birth within the family.

Death of a Member:

• In a partnership, the death of a partner usually dissolves the partnership.
• In a Hindu Undivided Family, the death of a member does not dissolve the family business.

Management Rights:

• All partners have equal rights to participate in the business in a partnership.
• In a Joint Hindu Family, management rights typically belong to the Karta, the leading member of the family.

Authority to Bind:

• Every partner has the authority to bind the firm by their actions.
• The Karta or manager can contract on behalf of the family business and its members.

Liability:

• In a partnership, a partner's liability is unlimited.
• In a Hindu Undivided Family, only the Karta has unlimited liability; other members are liable only to the extent of their share in the profits.

Calling for Accounts on Closure:

• A partner can sue for accounts upon dissolution of the firm.
• A member of a Joint Hindu Family cannot demand accounts upon separation.

Governing Law:

• Partnerships are governed by the Indian Partnership Act, 1932.
• Joint Hindu Family businesses are governed by Hindu Law.

Minor’s Capacity:

• A minor cannot become a partner in a partnership but can be admitted to the benefits of partnership with consent.
• In a Hindu Undivided Family, a minor automatically becomes a member of the business by birth.

Continuity:

• A partnership can be dissolved by the death or insolvency of a partner, subject to the contract.
• A Joint Hindu Family continues to exist until it is partitioned, unaffected by the death of a member.

Number of Members:

• A partnership cannot exceed 50 members.
• A Hindu Undivided Family engaged in business can have an unlimited number of members.

Share in the Business:

• In a partnership, each partner has a specific share as per the agreement.
• In a Hindu Undivided Family, no coparcener has a fixed share; their interest varies and can change with family births and deaths.

Difference Between Partnership and Co-Ownership

Partnership vs. Association

Kinds of Partnerships

1. Partnership at Will:

• Defined by Section 7 of the Indian Partnership Act, a partnership at will exists when:
• No fixed duration has been agreed upon for the partnership.
• There is no provision for determining the partnership's end.
• Both conditions must be met for a partnership to qualify as a partnership at will.
• If partners agree on a duration or a method for ending the partnership, it cannot be classified as a partnership at will.
• If a partnership with a fixed term continues after its expiration, it is considered a partnership at will.
• A partnership at will can be dissolved by any partner giving written notice to the other partners.

2. Partnership for a Fixed Period:

• A partnership is termed 'for a fixed period' when the contract stipulates a specific duration for the partnership.
• Such partnerships are created for a designated period and conclude upon the expiry of that period.

3. Particular Partnership:

• A partnership can be formed for a specific venture or for ongoing business activities.
• When a person partners with another for a specific adventure or undertaking, it is called a particular partnership.
• Unless otherwise agreed, a partnership established for a single adventure or undertaking is dissolved upon its completion.

4General Partnership:

• Definition: A general partnership is formed when partners come together to conduct business without any limitations on the scope of their activities. In this type of partnership, all partners share equal responsibility and liability for the business.
• Liability: In a general partnership, partners have unlimited liability. This means that their personal assets can be used to cover the debts and obligations of the partnership. This is different from a limited liability partnership (LLP), where partners' liabilities are restricted.
• Difference from Particular Partnership: A general partnership differs from a particular partnership in terms of liability. In a particular partnership, the liability of partners is limited to a specific venture or undertaking. In contrast, a general partnership does not have such limitations, and partners are jointly and severally liable for all aspects of the business.

Partnership Agreement

• Formation: A partnership is the result of an agreement between parties. There are no strict formalities required for forming a partnership agreement; it can be verbal or written. However, having a written agreement is advisable to prevent potential disputes in the future.
• Partnership Deed: The written document outlining the terms and conditions governing the relationship between partners is called the "partnership deed." It is essential to draft this document carefully, ensuring that it reflects the mutual understanding of the partners. Additionally, the partnership deed should be stamped in accordance with the Stamp Act, 1899.
• Partnerships Involving Immovable Property: If the partnership involves immovable property, such as land or buildings, the partnership instrument must be in writing, stamped, and registered under the Registration Act. This legal requirement helps establish the validity and enforceability of the partnership agreement in such cases.

Details Typically Included in a Partnership Deed

• Name of the partnership firm.
• Names of all the partners.
• Nature and place of the business of the firm.
• Date of commencement of partnership.
• Duration of the partnership firm.
• Capital contribution of each partner.
• Profit Sharing Ratio of the Partners.
• Admission and Retirement of a partner.
• Rates of interest on Capital, Drawings, and loans.
• Provisions for settlement of accounts in the case of dissolution of the firm.
• Provisions for salaries or commissions payable to the partners, if any.
• Provisions for expulsion of a partner in case of gross breach of duty or fraud.
• A partnership firm may add or delete any provision according to the needs of the firm.

Types of Partners

Partners in a partnership can be classified into different types based on the extent of their liability and involvement in the business. Here are the various types of partners:

• Active or Ostensible Partner: This partner is actively involved in the management and operations of the partnership. They have unlimited liability, meaning their personal assets are also at risk in case of business debts.
• Nominal Partner: A nominal partner does not participate in the day-to-day operations of the business but lends their name to the partnership. They have limited liability and are not personally liable for business debts.
• Sub-partner: A sub-partner is a partner in a partnership who takes on a portion of the profits and losses of the partnership but is not directly involved in its management. They have a limited role and liability.
• Outgoing Partner: An outgoing partner is a partner who decides to leave the partnership. Their liability may continue for debts incurred during their tenure.
• Sleeping or Dormant Partner: This partner is not involved in the active management of the business but is entitled to a share of the profits. They have unlimited liability.
• Incoming Partner: An incoming partner joins the partnership and agrees to the terms and conditions set by the existing partners. Their liability is typically outlined in the partnership agreement.
• Partner by Holding Out: This type of partner is not an actual partner but holds themselves out as one, leading third parties to believe they are part of the partnership. Their liability may arise from this representation.

Active or Actual or Ostensible Partner

An active or actual partner is someone who becomes a partner through an agreement and actively participates in the partnership's activities. This type of partner acts as an agent for the other partners in all matters related to the ordinary course of business. If an active partner decides to retire, they must give public notice to free themselves from liabilities for actions taken by other partners after their retirement.

Sleeping or Dormant Partner

A sleeping or dormant partner is an individual who is a partner by agreement but does not take an active role in the management of the partnership business. Despite their lack of involvement, these partners share in the profits and losses of the business and are legally responsible to third parties for all actions of the firm. Unlike active partners, sleeping partners are not required to give public notice when they retire from the partnership.

Nominal Partner:

• A nominal partner is someone who lends their name to a partnership firm without having any real interest or involvement in the business.
• Unlike other partners, a nominal partner is not entitled to share in the profits of the firm, nor do they invest in the business or participate in its management.
• However, nominal partners are still liable to third parties for all acts and obligations of the firm.
• In essence, a nominal partner's role is limited to providing their name and reputation to the firm, while they have no genuine stake in its activities or profits.

Partner in Profits Only:

• A partner in profits only is someone who is entitled to share in the profits of a business but is not responsible for its losses.
• However, this type of partner is still liable to third parties for acts related to the profits they are entitled to.
• In other words, while they benefit from the profits, they do not bear the risk of losses, but their liability to third parties remains intact.

Incoming Partners:

• An incoming partner is an individual who joins an existing partnership with the consent of all current partners.
• This new partner is not held liable for any actions or deeds of the firm that occurred before their admission.
• However, they are responsible for any actions or decisions made after they become a partner in the firm.

Example 5: Mr. A joined as a partner on 10th September, 2021 in a firm MNQ Associates which was existing from 10th July, 2017. Mr. A will not be liable for any acts of the firm done before his date of joining i.e. 10th September, 2021

Outgoing Partner

• An outgoing partner, also known as a retiring partner, is an individual who leaves a partnership while the remaining partners continue to run the business.
• Even after leaving, the outgoing partner is still responsible for the actions of the firm until a public notice of their retirement is issued.

Partner by Holding Out (Section 28)

• Partnership by holding out, also referred to as partnership by estoppel, occurs when a person presents themselves as a partner in a business or allows others to do so.
• In such cases, the individual cannot deny the partnership role they have assumed, as creditors may have acted based on this belief.
• Essentially, this legal concept prevents a person from contradicting their assumed partnership status, which has influenced the actions of creditors.

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 6: Let's say X and Y are partners in a business. X introduces A, a manager, as his partner to Z. A doesn't say anything to correct this impression. Z, believing A is a partner, supplies 100 TV sets to the firm on credit. When Z doesn't get paid after the credit period, he sues X and A for the money. In this situation, A is also responsible for the payment because he was holding out, as per Section 28 of the Indian Partnership Act, 1932.

Key Points:

• Holding Out Definition: When a person falsely represents themselves as a partner in a firm, they can be held liable like a real partner to those who rely on that representation.
• Inducing Belief: A person can induce others to believe they are a partner through their words or actions, or by allowing others to represent them as such.
• Liability: Only the person to whom the representation was made and who acted on it has the right to enforce liability arising from holding out.
• Fraudulent Intent: Proving fraudulent intent is not necessary to establish liability for holding out.
• Former Partners: The rule in Section 28 applies to former partners who retire without proper public notice. Creditors who believe a former partner is still involved can hold them liable.
• Example of Former Partner: If S retires from a partnership firm without public notice and creditors continue to believe he is a partner, he can be held liable for debts incurred after his retirement.

Example 7: Consider a partnership firm with P, Q, R, and S as partners. If S retires from the firm without giving proper public notice, and his name is still used on the firm's letterheads, S can be held liable as a partner to creditors who lent money based on the belief that he was still a partner.