Dissolution of Firm

Author: Ritik Saluja, GGSIPU, Delhi

Concept of Partnership

Partnership is defined in the Indian Partnership Act, 1932 as a relation between persons who have agreed to share the profits of a business carried on by all or any of them acting for all. All the individuals who agree to be in a relationship of a partnership are individually called partners.

Together all the partners will be called ‘Firm’. Nature of partnership:

Partnership will always be created by a contract and will not be the result of status.

Sharing of profits is not the sole test to determine whether a partnership exists or not. The existence of a partnership will be determined by the facts and circumstances of each case. Given in section 6 of the Indian Partnership Act, 1932 that following cases, will not result in the formation of partnership by reason of agreement of sharing of profits only,

(a) by a lender of money to persons engaged or about to engage in any business

(b) by a servant or agent as remuneration,

(c) by the widow or child of a deceased partner, as an annuity, or

(d) by a previous owner or part-owner of the business, as consideration for the sale of the goodwill or share thereof.

There are two types of partnership : (i) Partnership at Will: Where no provision is made by contract between the partners for the duration of their partnership, or for the determination of their partnership, the partnership is “partnership-at-will”.

(ii) Particular Partnership: A person may become a partner with another person in particular adventures or undertakings.

Methods of Dissolution of a Partnership Firm

When any of the individuals previously acting as partners, no longer enjoy the relationship of being a partner with any other such individual, the firm is said to be dissolved.

Following are the methods of dissolution of firms :

Dissolution by Agreement: A firm may be dissolved when all the partners in the firm mutually consent for such dissolution.

Dissolution by notice of partnership at will: When there is partnership-at-will any of the partners can dissolve the firm by giving notice to all other members. The firm will stand dissolved as from the date mentioned in the notice or if no such date is mentioned from the date of communication of the notice.

Dissolution by Certain Contingencies: There are certain situations in which firms get dissolved such as :

when firm constituted for a certain time, on the expiration of term,

when firm constituted to carry out some particular adventure(s), on completion of such tasks,

on the death of a partner,

when a partner is declared insolvent.

  • Compulsory Dissolution :
  • When all the partners or all except one are declared insolvent by a court of competent jurisdiction,
  • When the whole of the business carried out by the firm is declared illegal.
  • Dissolution by Court: Court may dissolve a firm on following grounds on a suit by one of the partners : (a) when one of the partners, other than the partner suing, becomes of unsound mind;

(b) when one or more partners, other than the partner suing, become permanently incapable(in any way) to perform their duties;

(c) when the business of firm cannot be carried on, except on loss;

(d) when one or more partners, other than the partner suing, wilfully breach any of the agreement in regard to the management of the affairs of the firm;

(e) when one or more partners, other than the partner suing, is/are guilty of conduct prejudicial to the business of the firm;

(f) any other grounds court deems just and equitable to dissolve the firm.

Rights and Liabilities of Partners and Third parties after the dissolution of the firm.

Right of Partners

Any of the partners or his representatives have the right to compel other partners to pay for the losses or any debt due on the firm first and if there remains any residue to be distributed among all the partners according to their proportional shares.

Unless there is a contract to the contrary, every partner or his representatives have the right to refrain every other partner from using firm-name or firm-properties in any of their future ventures.

Every partner or his representatives have the right to restrain other partners from carrying out the business of the same nature as was carried out by the firm, if there is an agreement done in this regards in anticipation of dissolution or otherwise.

Liabilities of Partners

  1. Every partner has liability to carry out business with third parties even after dissolution unless public notice of such dissolution of the firm has been published.
  2. Every partner has liability to wind up the business of the firm before leaving.
  3. Every partner has a liability not to use firm-name or firm-properties after the dissolution of the firm unless he has contracted to buy the goodwill of the firm.

Rights and liabilities of Third Parties

Third Parties have the right to demand payment of the remaining balance and in regards to any business conducted with them by any of the partners unless a public notice in regards to dissolution of the firm has been published.

Similar to their rights third parties are liable for all their actions carried out in the course of business with the firm.

Settlement of Accounts after Dissolution of Firm

Following rules will be observed for settlement of accounts between partners after the dissolution of the firm :

  • Losses, including deficiencies of capital, shall be paid first out of profits, next out of capital, and, lastly, if necessary, by the partners individually in the proportions in which they were entitled to share profits,
  • the assets of the firm, including any sums, contributed by the partners to make up deficiencies of capital, shall be applied in the following manner and order :
  • in paying the debts of the firm to third parties;
  • in paying to each partner rateably what is due to him from the firm for advances as distinguished from capital;
  • in paying to each partner rateably what is due to him on account of capital; and
  • the residue, if any, shall be divided among the partners in the proportions in which they were entitled to share profits,

Settlement in case if both joint debt and private debt due: ​Where there are joint debts due from the firm, and also separate debts due from any partner, the property of the firm shall be applied in the first instance in payment of the debts of the firm, and, if there is any surplus, then the share of each partner shall be applied in payment of his separate debts or paid to him. The separate

property of any partner shall be applied first in the payment of his separate debts, and the surplus (if any) in payment of the debts of the firm.

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