UNIT 2:

The Indian Partnership Act, 1932

When two or more people come together as partners, they can form a partnership firm. This
partnership firm is governed by the rules and regulations of the Indian Partnership Act, 1932.

Definition of Partnership
Section 4 of the Indian Partnership Act defines a partnership as “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”.

Meaning of Partnership
In a partnership firm, two or more people come together to carry out a business for the purpose
of earning profits and sharing those profits. The partners combine their capital resources and
work jointly to carry on the business. According to Section 12 of the Indian Partnership Act, a
partnership must be formed for the purpose of carrying a business that is legal in nature.

Essentials of a Partnership
• There must be an agreement between the partners to carry on the business of the
partnership firm.
• The aim of the formation of the partnership should be to earn profits and share them
among partners. The sharing of profit and losses can either be according to the ratio of
the capital contributed by each partner or be equally among all the partners unless
otherwise specified.
• The partnership agreement must state that the business will be jointly carried on by all of
them or some of them acting on the behalf of all. According to Section 13 of the
Partnership Act, 1932, the mutual agency exists between the partners. Every partner in a
partnership acts as a principal as well as an agent for other partners. The actions of a
partner are binding on the actions of all the other partners.
• Unlimited Liability- The partners can be held liable jointly for any debts of the firm.
They have an unlimited liability that extends to their private assets for the disposal of the
firm’s debts.

Number of Partners in a Partnership

According to the Indian Partnership Act, there is no limit on the maximum number of partners
that can be there in partnership but there must be a minimum of two partners. However,
according to Companies Act 2013, the maximum number of partners must not exceed 100 in
case of a partnership. If the number of members in a partnership exceeds 100 then it is termed as
an illegal association as per Section 464 of the Companies Act, 2013.

Partnership Deed
The partnership agreement forms the basis of a partnership. It is the foundation that creates a
legal relationship between the partners to carry out the business of the partnership firm. A
partnership agreement can either be written or oral but in the written format it is known as the
partnership deed. Some of the details mentioned in a partnership deed are as follows.
• Name and address of the partnership firm as well as that of the business
 • Name and address of all the partners
• Rights, duties, and obligation of partners
• Profit and loss sharing ratio
• Capital contribution by each partner
• Rate of interest on capital, loan, drawings
• Settlement of accounts in the event of the dissolution of the firm
• Mode of settlement in the event of disputes among partners
• Salaries and commission payable to partners
• Rules to be followed in the event of the admission of a new partner, retirement and death
of an existing partner
• Any other provisions affecting the rights of the partners
Essential Features of a Partnership
Two or More than Two Persons – in order for a firm to come into existence, it should involve
two or more than two partners, who have a vested interest in a common goal. However,
according to section 464 of the companies act of 2013, the central government has prescribed a
limit on the maximum number of partners a firm can hold. Therefore, According to the central
government, the maximum number of partners a firm can hold is 50.
Legal Agreement- Partners who come together to form a firm, already have a mindset that they
will be sharing both profits and losses of the firm equally. These agreements, if made orally are
valid however it is advised to get these agreements written in a legal form to avoid disputes in
the future.
Partners in Business- In order to be partners in business, there should be some business going
on in the firm that only then can they be called Business partners and only then can the Indian
partnership act of 1932 be applicable to them.
Mutual Agreements - In order for a partnership to take place, a Mutual agreement on the mutual
agency is extremely important. Partners of a firm can make rules and bind other partners to it and
also bound to the rules that are made by other partners of the firm. Every partner is allowed to
make decisions and conduct the affairs of the business according to him/her.
Elements of a Partnership

The Indian Partnership Act 1932 defines a partnership as a relation between two or more persons
who agree to share the profits of a business run by them all or by one or more persons acting for
them all.

1] Contract for Partnership

A partnership is contractual in nature. As the definition states a partnership is an association of two
or more persons. So a partnership results from a contract or an agreement between two or more
persons. A partnership does not arise from the operation of law. Neither can it be inherited. It has to
be a voluntary agreement between partners.
A partnership agreement can be written or oral. Sometimes such an agreement is even implied by
the continued actions and mutual understanding of the partners.

2] Association of Two or More Persons

A partnership is an association between two or more persons. And persons only include individuals,
not other firms. The law also prohibits minors from being partners. But minors can be admitted to
the benefits of a partnership.

3] Carrying on of Business
There are two aspects of this element. Firstly the firm must be carrying on some business. Here the
business will include any trade, profession or occupation. Only that some business must exist and
the partners must participate in the running of such business.

Also, the business must be run on a profit motive. The ultimate aim of the business should be to
make gains, which are then distributed among the partners. So a firm carrying on charitable work
will not be a partnership. If there is no intention to earn profits, there is no partnership.

4] Profit Sharing
The profit sharing ratio or the manner of sharing profits is not important. But one partner cannot be
entitled to the entire profits of the firm.

However, the sharing of losses is not of any essence. It is up to the partners whether the losses will
be shared by all the partners. If nothing is said then the losses are also split in the profit sharing
ratio.

5] Mutual Agency
This means that every partner is both a principle as well as an agent for all the other partners of the
firm. An act done by any of the partners is binding on all the other partners and the firm as well.
And so every partner is bound by the acts of all the other partners. It is, in fact, the truest test of a
partnership.

Kinds of Partnership

The distinction between partnerships can be done on the basis of two criteria. They are as follows

1. With Regard to the Duration of the partnership – either Partnership at Will or Partnership for
Fixed Duration
 2. With regards to the extent of the business carried by the partnership – either General
Partnership or Particular Partnership
1] Partnership at Will
When forming a partnership if there is no clause about the expiration of such a partnership, we call
it a partnership at will. According to Section 7 of the Indian Partnership Act 1932, there are
two conditions to be fulfilled for a partnership to be a partnership at will. These are

• There is no agreement about a fixed period for the existence of a partnership.

• No provision with regards to the determination of a partnership

So if there is an agreement between the partners about the duration, this will not be a partnership at
will. But if a partnership was entered into a fixed term and continues to operate beyond this term it
will become a partnership at will from the expiration of this term.

2] Partnership for a Fixed Term

Now during the creation of a partnership, the partners may agree on the duration of this
arrangement. This would mean the partnership was created for a fixed duration of time.

3] Particular Partnership
A partnership can be formed for carrying on continuous business, or it can be formed for one
particular venture or undertaking. If the partnership is formed only to carry out one
business venture or to complete one undertaking such a partnership is known as a particular
partnership. After the completion of the said venture or activity, the partnership will be dissolved.

4] General Partnership
When the purpose for the formation of the partnership is to carry out the business, in general, it is
said to be a general partnership. In a general partnership the scope of the business to be carried out
is not defined. So all the partners will be liable for all the actions of the partnership.

Types of Partners

1] Active Partner/Managing Partner

An active partner is also known as Ostensible Partner. As the name suggests he takes active
participation in the firm and the running of the business. He carries on the daily business on behalf
of all the partners. This means he acts as an agent of all the other partners on a day to day basis and
with regards to all ordinary business of the firm.
Hence when an active partner wishes to retire from the firm he must give a public notice about the
same. This will absolve him of the acts done by other partners after his retirement. Unless he gives a
public notice he will be liable for all acts even after his retirement.

2] Dormant/Sleeping Partner
This is a partner that does not participate in the daily functioning of the partnership firm, i.e. he does
not take an active part in the daily activities of the firm. He is however bound by the action of all the
other partners.

He will continue to share the profits and losses of the firm and even bring in his share of capital like
any other partner. If such a dormant partner retires he need not give a public notice of the same.

3] Nominal Partner
This is a partner that does not have any real or significant interest in the partnership. So, in essence,
he is only lending his name to the partnership. He will not make any capital contributions to the
firm, and so he will not have a share in the profits either. But the nominal partner will be liable to
outsiders and third parties for acts done by any other partners.

4] Partner by Estoppel
If a person holds out to another that he is a partner of the firm, either by his words, actions or
conduct then such a partner cannot deny that he is not a partner. This basically means that even
though such a person is not a partner he has represented himself as such, and so he becomes partner
by estoppel or partner by holding out.

5] Partner in Profits Only

This partner will only share the profits of the firm, he will not be liable for any liabilities. Even
when dealing with third parties he will be liable for all acts of profit only, he will share none of the
liabilities.

6] Minor Partner
A minor cannot be a partner of a firm according to the Contract Act. However, a partner can be
admitted to the benefits of a partnership if all partner gives their consent for the same. He will share
profits of the firm but his liability for the losses will be limited to his share in the firm.

Such a minor partner on attaining majority (becoming 18 years of age) has six months to decide if
he wishes to become a partner of the firm. He must then declare his decision via a public notice. So
whether he continues as a partner or decides to retire, in both cases he will have to issue a public
notice.
Relation of Partners with One Another
All partners are free to form their own terms and conditions with respect to functioning in their
partnership deed. The Indian Partnership Act, 1932 has also prescribed provisions to govern their
relationship inter se (amongst them), and these provisions are applicable if no such deed exists. Let
us take a look at the duties and the rights of partners.

Rights of Partners Inter Se

Partners can exercise the following rights under the Act unless the partnership deed states otherwise:

1. Right to participate in business: Each partner has an equal right to take part in the conduct
of their business. Partners can curtail this right to allow only some of them to contribute to
the functioning of the business if the partnership deed states so.

2. Right to express opinions: Another one of the rights of partners is their right to freely
express their opinion. Partners, by a majority, can determine differences with respect to
ordinary matters connected with the business. Each partner can express his opinion to decide
such matters.

3. Right to access books and accounts: Each partner can inspect and copy books of accounts
of the business. This right is applicable equally to active and dormant partners.

4. Right to share profits: Partners generally describe in their deed the proportion in which they
will share profits of the firm. However, they have to share all the profits of the firm equally if
they have not agreed on a fixed profit sharing ratio.

5. Right to be indemnified: Partners can make some payments and incur liabilities through
their decisions in the course of their business. They can claim indemnity from each other for
these decisions. Such decisions must be taken in situations of emergency and should be of
such nature that an ordinarily prudent person would resort to under similar conditions.

6. Right to interest on capital and advances: Partners generally do not get an interest on the
capital they contribute. In case they decide to take an interest, such payment must be made
only out of profits. They can, however, receive interest of 6% p.a. for other advances made
subsequently towards the business.
Duties of Partners inter se

Now that we have seen the rights of partners let us see the duties the Act has prescribed,

1. General duties: Every partner has the following general duties like carrying on the business
to the greatest common good, duty to be just and faithful towards each other, rendering
true accounts, and providing full information of all things affecting the firm. etc
 2. Duty to indemnify for fraud: Every partner has to indemnify the firm for losses caused to it
by his fraud in the conduct of business. The Act has adopted this principle because the firm is
liable for wrongful acts of partners. Any partner who commits fraud must indemnify other
partners for his actions.

3. Duty to act diligently: Every partner must attend to his duties towards the firm as diligently
as possible because his not functioning diligently affects other partners as well. He is liable to
indemnify others if his willful neglect causes losses to the firm.

4. Duty to use the firm’s property properly: Partners can use the firm’s property exclusively
for its business, and not for any personal purpose, because they all own it collectively. Hence,
they must be careful while using these properties.

5. Duty to not earn personal profits or to compete: Each partner must function according to
commonly shared goals. They should not make any personal profit and must not engage in
any competing business venture. They should hand over personal profits made to their firm.
Effect on Rights and Duties after a change in Firm

The nature of the existing relationship between partners will be affected whenever there is a change
in the firm’s constitution. Such changes occur in the following situations:

1. Change in constitution of the firm due to incoming or outgoing or partner(s);

2. Expiry of the pre-determined term of the firm; and

3. Carrying out of additional business undertakings than originally agreed upon.

Relation of Partners to Third Parties

A Partner is an Agent of the Firm (Section 18)

A partnership is a relationship between partners who agree to share the profits of the business. The
business can be carried on by all of them or any of them acting for all. This definition suggests that a
partner can be an agent of the others.

Hence, a partner embraces the character of both, the principal and the agent. Therefore, if he acts for
himself and in his own interest in the common concern of the partnership, then he is acting as a
principal. On the other hand, if he acts for and in the interest of his partners, then he is acting as
an agent.

It is important to note that a partner is an agent only or the purpose of business of the firm. He is not
an agent for all transactions and dealings between the partners themselves.
Implied Authority of a Partner (Section 19)

If a partner does an act in the usual course of business of the firm, then his act binds the firm.
This authority of a partner to bind the firm is Implied Authority. Unless a contrary agreement exists,
implied authority does not empower a partner to (Section 19 – subsection 2 of the Indian
Partnership Act, 1932):

• Submit a dispute, relating to the business of the firm, to arbitration

• Open a bank account in his name, on behalf of the firm

• Compromise full or part of a claim by the firm

• Withdraw a suit or proceedings filed on behalf of the firm

• Admit any liability in a suit or proceedings against the firm

• Acquire an immovable property on behalf of the firm

• Transfer an immovable property belonging to the firm

• Enter into a partnership on behalf of the firm

Section 22 of the Indian Partnership Act, 1932, adds that the act which was done by the partner to
bind the firm must be done in the name of the firm or in any other manner which implies an
intention to bind the firm.

While the implied authority depends on the nature of the business of the firm, a partnership of a
general commercial nature may allow the partner to:

• Pledge or sell the partnership property

• Purchase goods on behalf of the partnership

• Borrow money, contract and pay debts on account of the partnership

• Draw, make, sign, endorse, transfer, negotiate and procure negotiable papers in the name and
on account of the partnership.
According to Section 20 of the Indian Partnership Act, 1932, the partners of a firm can make a
contract to extend or restrict the implied authority of a partner.

These restrictions or extensions apply to a third party only when the third party is aware of the
restrictions or does not know that he is dealing with a partner of the firm.
 Partner’s Authority in an Emergency (Section 21)

As per Section 21 of the Indian Partnership Act, 1932, if there is an emergency, then every partner
has the authority to do all such acts that a person of ordinary prudence would do to protect the firm
from a loss. Such acts bind the firm.

Minors Admitted to Benefits of Partnership

Section 30 of the Indian Partnership Act 1932 contains legal provisions about a minor in a
partnership. Now we know the Indian Contract Act 1857 clearly states that no person less than the
age of 18, i.e. a minor can be a party to a contract. And a partnership is a contract between the
partners. Hence a minor cannot be a partner in a partnership firm.

However, according to the Partnership Act, a minor may be admitted to the benefits of a
partnership. So while the minor will not be a partner he will enjoy all the benefits of a partnership.
To admit the entire minor to the benefits of the partnership all of the partners of the firm must be in
agreement.

Rights of a Minor Partner

Once the minor is given the benefits in a partnership there are certain rights that he enjoys. Let us
take a look at the rights of a minor partner.

i. A minor partner will obviously have the right to his share of the profits of the firm. But the
minor partner is not liable for any losses beyond his interests in the firm. So a minor partner’s
personal assets cannot be liquidated to pay the firms liabilities.

ii. He can also like any other partner inspect the books of accounts of the firm. He can demand a
copy of the books as well.

iii. If necessary he can sue any or all of the other partners for his share of the profits or benefits.

iv. A minor partner on attaining majority has the right to become a partner of the firm. He has
six months from attaining majority to decide if he will execute this right. Whether he decides
to become a partner or not he must give public notice about the same.
Liabilities of a Minor Partner

i. A minor cannot be held personally liable for the losses of the firm. And if the firm declares
insolvency the minor’s share is kept with the Official Receiver

ii. After turning 18 the minor partner can choose to become a partner of the firm. But he may
choose to not become a partner. In this case, the minor partner has to give a public notice
about this decision. And the notice has to be given within 6 months of gaining a majority. If
 such a notice is not given even after 6 months then the minor partner will become liable for
all acts done by the other partners till the date of such notice.

iii. Should the minor partner choose to become a partner he will be liable to all the third parties
for the acts done by any and all partners since he was admitted to the benefits of
the partnership.

iv. If he becomes a full-time partner he will be treated as a normal partner and have all the
liabilities of one. His share in the profits and property of the firm will remain the same as it
was when he was a minor partner.
Right of an Outgoing Partner to Carry on a Competing Business

Section 36 (1) of the Indian Partnership Act, 1932 (Partnership law), imposes certain restrictions but
allows an outgoing partner to carry on a business and advertise it, which competes with the
partnership firm. However, it restricts him from:

• Using the name of the partnership firm

• Representing himself as a partner of the firm

• Soliciting the custom of persons who were dealing with the firm before he ceased to be a
partner.
An outgoing partner may make an agreement with his partners that when he ceases to be a partner
of the firm, he will not carry on any business similar to that of the firm within a specified period or
local limits.

Right of an Outgoing Partner to Share Subsequent Profits

According to Section 37, of the Partnership Law, if a member of the firm dies or otherwise ceases to
be a partner of the firm, and the remaining partners carry on the business without any final
settlement of accounts between them and the outgoing partner, then the outgoing partner or his
estate is entitled to share of the profits made by the firm since he ceased to be a partner.

The share may be attributable to the use of his share of the property of the firm or the interest at six
percent per annum on the amount of his share in the property.The surviving partners also have an
option of purchasing the interest of the deceased or outgoing partner. If the surviving partners
choose to purchase the interest, then the outgoing partner is not entitled to any further share in
profits of the firm.

Legal Consequences of Admission or Retirement of a Partner

Whenever there is an admission of a new partner or retirement of a partner, or expulsion or
insolvency of a partner, etc., the partnership firm undergoes reconstitution. Sections 31 to 35 of the
Indian Partnership Act, 1932 help us understand the legal consequences of a partner coming in or
going out.

Admission or Introduction of a Partner (Section 31)

According to this section, the consent of all the existing partners is necessary before introducing a
new partner into a partnership firm. This is subject to the provisions of Section 30 regarding minors
in the firm. Further, the new partner has no liability for any actions of the firm done before his
admission.

Rights and Liabilities of a New Partner

All liabilities of a new partner commence from the date of his admission as a partner in the firm.
This is unless he accepts liability for the obligations incurred by the firm before his admission.

So, after the admission of a new partner, the new firm may agree to assume liability for the debts of
the old firm and the creditors may accept the new firm as their debtor, discharging the old firm. It is
important to note that the creditor’s consent is important to make the transaction operative.

In a contract, the technical term for substituted liability is Novation (replacement). Hence, a mere
agreement amongst the partners cannot operate as Novation unless the creditors provide their
consent.

The retirement of a Partner (Section 32)

A partner retires when he ceases to be a member of the firm without ending the subsisting relations
between the other members of the firm or between the firm and other parties. If a partner withdraws
from a firm by dissolving it, then it is a dissolution and not retirement of a partner. The retirement of
a partner from a firm does not dissolve it.

In a partnership, a partner may retire:

• With the consent of all the partners,

• In accordance with an express agreement by the partners, or

• The partnership is at will, by giving notice in writing to all the other partners of his intention
to retire
Liabilities of an Outgoing Partner
A retired partner continues to be liable to the third party for acts of the firm till such time that he or
other members of the firm give a public notice of his retirement. However, if the third party deals
with the firm without knowing that he was a partner in the firm, then he will not be liable to the
third party.

The retired partner, however, continues to be liable for acts of the firm done before such retirement
of a partner. This liability holds good unless there is an agreement between him, the concerned third
party, and partners of the reconstituted firm. Such an agreement can also be implied by the course of
dealings between the third party and the reconstituted firm post announcement of the retirement of a
partner.

If the partnership is at will, then it can relieve a partner without giving a public notice. To do so, the
partnership needs to give a written notice to all the partners of his intention to retire.

Expulsion of a Partner (Section 33)

A partnership firm can expel a partner provided:

• The power of expulsion exists in the contract between the partners

• Majority of the partners exercise the power

• The power is used in good faith

If these conditions are not met, then the expulsion is not bona fide in the interest of the business.
The test of good faith includes three aspects:

1. The expulsion should be in the interest of the partnership.

2. Before expelling a partner the firm serves a notice to him.

3. The partner being expelled is given an opportunity to state his version of events leading up to
the expulsion.
If these aspects are not met, then the expulsion is not considered to be made in good faith and is null
and void. It is important to note that the expulsion of partners does not necessarily result in the
dissolution of the firm.

Insolvency of a Partner (Section 34)

When a partner of a firm is adjudicated as insolvent –

• He ceases to be a partner of the firm from the date of the adjudication

• Whether or not the firm subsequently dissolves

 • His estate, which vests in the official assignee, ceases to be liable for any act of the firm from
the said date

• The firm ceases to be liable for any act of such a partner.

Liability of Estate of a Deceased Partner (Section 35)

Usually, the death of a partner results in the dissolution of the partnership. However, if the partner’s
contract to not dissolve the partnership posts the death of any partner, then the surviving partner
continue the business of the firm after absolving the deceased partner’s estate from any liability of
the future obligations of the firm.

Further, it is not necessary for the firm to give a public notice or inform the persons dealing with the
firm about the death of the partner.

An exception is a partnership consisting of only two partners. In such cases, the death of a partner
results in the dissolution of the partnership.

Consequences of Non Registration of Firm

1] No suit in a civil court by the firm or other co-partners against any third party
If the firm registration is not done, then the firm or any other person on its behalf cannot file a suit
against a third party for breach of contract which the firm has entered into. Further, the person filing
the suit on behalf of the firm should be in the register of the firm as a partner.

2] No relief to partners for set-off of claim

Without firm registration, any action brought against the firm by a third party having a value of
more than Rs. 100 cannot be set-off by the firm or any of its partners. Pursuance of other
proceedings to enforce rights arising from the contract cannot be done either.

3] An aggrieved partner cannot bring legal action against other partner or the firm
A partner of the firm or any person on his behalf cannot bring legal action against the firm or
against any partner (or alleged to be a partner) if firm registration is not done. However, if the firm
is dissolved, then such a person can sue the firm for dissolution it accounts and realization of his
share in the firm’s property.

4] A third party can sue the firm

Even if the firm registration is not done a third party can bring legal action against the firm.
It is also, important to note that despite these disabilities, the non-registration of a firm does not
affect the following rights:

1. The right of a third party to sue the firm or any partner

2. Partners’ right to sue the firm for dissolution or settlement of accounts (in case of dissolution)

3. The power of the Official Assignees, Receiver of Court to release the property of the
insolvent partner and bring an action

4. The right of the firm and partners to sue or claim set-off of the value of the suit does not
exceed Rs. 100.

Dissolution of a Firm
When the partnership between all the partners of a firm is dissolved, then it is called dissolution of a
firm. It is important to note that the relationship between all partners should be dissolved for the
firm to be dissolved. Let us look at the legal provisions for the dissolution of a firm.

Modes of Dissolution of a Firm

• Voluntary Dissolution of a Firm

• Dissolution By an order of the Court.

Voluntary dissolution can be of four types.

1] By Agreement (Section 40): According to Section 40 of the Indian Partnership Act, 1932,
partners can dissolve the partnership by agreement and with the consent of all partners. Partners can
also dissolve the partnership based on a contract that has already been made.

2] Compulsory Dissolution (Section 41): An event can make it unlawful for the firm to carry on
its business. In such cases, it is compulsory for the firm to dissolve. However, if a firm carries on
more than one undertakings and one of them becomes illegal, then it is not compulsory for the firm
to dissolve. It can continue carrying out the legal undertakings. Section 41 of the Indian Partnership
Act, 1932, specifies this type of voluntary dissolution.

3] On the happening of certain contingencies (Section 42)

• Some firms are constituted for a fixed term. Such firms will dissolve on the expiry of that
term.
 • Some firms are constituted to carry out one or more undertaking. Such firms are dissolved
when the undertaking is completed.

• Death of a partner.

• Insolvent partner.
4] By notice of partnership at will (Section 43)
According to Section 43 of the Indian Partnership Act, 1932, if the partnership is at will, then any
partner can give notice in writing to all other partners informing them about his intention to dissolve
the firm.

In such cases, the firm is dissolved on the date mentioned in the notice. If no date is mentioned, then
the date of dissolution of the firm is the date of communication of the notice.

Dissolution of a Firm by the Court

According to Section 44 of the Indian Partnership Act, 1932, the Court may dissolve a firm on the
suit of a partner on any of the following grounds:

1] Insanity/Unsound mind
If an active partner becomes insane or of an unsound mind, and other partners or the next friend
files a suit in the court, then the court may dissolve the firm. Two things to remember here:

• The partner is not a sleeping partner

• The sickness is not temporary

2] Permanent Incapacity
If a partner becomes permanently incapable of performing his duties as a partner, and other partners
file a suit in the court, then the court may dissolve the firm. Also, the incapacity may arise from a
physical disability, illness, etc.

3] Misconduct
When a partner is guilty of conduct which is likely to affect prejudicially the carrying on of the
business and the other partners file a suit in the court, then the court may dissolve the firm.

Further, it is not important that the misconduct is related to the conduct of the business. The court
looks at the effect of the misconduct on the business along with the nature of the business.
4] Persistent Breach of the Agreement
A partner may willfully or persistently commit a breach of the agreement relating to

• the management of the affairs of the firm, or

• a reasonable conduct of its business, or

• Conduct himself in matters relating to business that is not reasonably practicable for other
partners to carry on the business in partnership with him.
In such cases, the other partners may file a suit against him in the court and the court may order to
dissolve the firm. The following acts fall in the category of breach of agreement:

1. Embezzlement(stealing or secretly taking money)

2. Keeping erroneous(incorrect) accounts

3. Holding more cash than allowed

4. Refusal to show accounts despite repeated requests, etc.

5] Transfer of Interest
A partner may transfer all his interest in the firm to a third party or allow the court to charge or sell
his share in the recovery of arrears of land revenue. Now, if the other partners file a suit against him
in the court, then the court may dissolve the firm.

6] Continuous/Perpetual losses
If a firm is running under losses and the court believes that the business of the firm cannot be carried
on without a loss in the future too, then it may dissolve the firm.

7] Just and equitable grounds

The court may find other just and equitable grounds for the dissolution of the firm. Some such
grounds are:

• Deadlock in management

• Partners not being in talking terms with each other

• Loss of substratum (the foundation of the business)

• Gambling by a partner on the stock exchange.

 Difference between Dissolution of a firm and Dissolution of a Partnership

Parameters Dissolution of a Firm Dissolution of a Partnership

Continuation of The business continues. However, the

The business discontinues.
business partnership is reconstituted.

The firm is wound up. Assets

Assets and liabilities of the firm are
Winding up are realized and liabilities are
only revalued.
settled.

A Court Order can dissolve a A Court Order cannot dissolve a

Court order
firm. partnership.

It involves the dissolution

It does not involve the dissolution of
Scope of partnership between
the firm.
all partners.

Final closure of books Yes No

Consequences of Dissolution of a Firm

After the dissolution of firm, the partners have certain rights and liabilities. Sections 45 to 55 of the
Indian Partnership Act, 1932, provides details on the consequences of the dissolution of a firm.
Liability for Acts done by Partners after the Dissolution of Firm (Section 45)

According to this section, the partners of a firm are liable to a third party for any act done by any of
them unless they give a public notice of the dissolution. This notice can be given by any partner. It
also specifies that the estate of a partner who dies, retires from the firm, becomes insolvent, or that
of a person who the third party is not aware of being a partner of the firm, is not liable under this
section (from the date he ceases to be a partner).

In simple words, Section 45 endeavors to protect third parties who have no clue about the
dissolution of firm and also the partners of a dissolved firm from liabilities towards third parties
post-dissolution.

Wind up the Business Post-Dissolution (Section 46)

Once a firm is dissolved, every partner or his representative has a right to apply the property of the
firm in payments of debts and liabilities of the firm. The surplus, if any, can be distributed among
the partners according to their rights.

Also according to section 47 post-dissolution, the authority of each partner to bind the firm, along
with other mutual rights and obligations, continue till such time that they can wind up the affairs of
the firm.

This gives them a chance to complete the unfinished transactions at the time of dissolution. This
does not include the acts of a partner who has been adjudicated insolvent.

Settlement of Partnership Accounts (Section 48)

Section 48 lays down certain rules for settlement of partnership accounts after the dissolution of
firm under the usual course of business. However, the partners can mutually agree for a different
settlement mode. The rules are as follows:

1. Any losses or deficiencies of capital will be paid out of profits. If the profits are not
sufficient, then they are paid out of the capital and finally, if necessary, by the partners. The
partners contribute in the proportion in which they receive their share in profits.

2. The assets of the firm, which includes the sums contributed by the partners to make up for
the deficiency in the capital, is applied in the following order:
1. Repaying the debts of the firm to third parties

2. Paying each partner rateably what is due to him from the capital

3. Paying each partner rateably what is due to him on account of capital

 4. If any amount is left, then dividing it among the partners in proportions in which they
receive their share in profits.
Paying Firm Debts and Separate Debts (Section 49)

If there are joint debts due from the firm and separate debts due from any partner, then:

• The payment of firm debts is given priority. If there is any surplus, then the share of each
partner is applied to his separate debts. It can also be paid to him.

• The separate property of the partner is applied first in the payment of his separate debts. IF
there is any surplus, then it is applied to the payment of firm debts.
Personal Profits Earned after Dissolution of Firm (Section 50 and 53)

A firm is dissolved by the death of a partner. If the surviving partners, either themselves or with the
representative of the deceased partner carry on the business of the firm, then they have to account
for any personal profits by them, before winding up the firm.

So, if a lease expires on the death of a partner and the surviving partners renew it before the firm
winds up, then the profits belong to the firm.

Section 53 clearly states that in the absence of an agreement to the contrary, a partner can restrain
other partners from carrying on a similar business in the name of the firm or from using the property
of the firm for their own benefit, unless the winding up process is complete.

Return of Premium on the Premature Dissolution of Firm (Section 51)

If a firm dissolves earlier than the time fixed for it, then the partner paying the premium can receive
a return of a reasonable part of the premium. This holds true except when the partnership is
dissolved:

• Due to the death of a partner

• Due to the misconduct of the partner paying the premium

• Post an agreement which has no provisions for the return of premium

Also, the partner paying the premium gets a return of a proportionate part of the premium. This
holds true when the partnership is dissolved:

• Without either partner being at fault

• Owing to the fault of both the partners

 • Due to the fault of the partner receiving the premium

• Due to unawareness about the insolvency of the partner receiving the premium
Contract Rescinded for Fraud or Misrepresentation (Section 52)

If the contract creating a partnership is rescinded due to fraud or misrepresentation, then the party
who can rescind the contract is entitled to:

• Lien on the assets of the firm remaining after the debts of the firm is paid. This lien is for any
sum paid by him for the purchase of a share in the firm and capital contributed by him.

• Rank as a creditor of the firm for any payment made by him towards the debts of the firm

• An indemnity from the partners guilty of the fraud or misrepresentation against all debts of
the firm.
Sale of Goodwill after the Dissolution of Firm (Section 55)

The goodwill is included in the assets during the settling of the accounts of a firm after dissolution.
The goodwill can be sold separately or along with the other assets of the firm. This is subject to the
contract between the partners.

Once the goodwill of the firm is sold after dissolution, a partner can carry on and advertise a
business competing with that of the buyer of goodwill. However, subject to the agreement between
him and the buyer, he may not:

• Use the name of the firm

• Represent himself as carrying on the business of the firm

• Solicit the customs of persons dealing with the firm before the dissolution
It is also important to note that a partner can make an agreement with the buyer of goodwill that he
will not carry on any business similar to that of the firm or with certain local limits. Such an
agreement, notwithstanding Section 27 of the Indian Contract Act is valid if the restrictions are
reasonable.