- The terms partner and partnership are defined under Section 4 of the Partnership Act.
- Dissolution of partnership firm is different for from dissolution of a partnership.
- Dissolution of a partnership firm is defined under Section 39 of the Act.
- Section 40 to Section 44 of the Act deals with different modes and grounds for dissolution of a partnership firm.
The Partnership Act, 1932 is a comprehensive law which seeks to regulate the relationship among the partners and between the partners and the third parties. Section 4 of the Partnership Act, 1932 defines a partnership as the relationship between persons who have agreed to share the profits of business carried on by all or any of them acting for all. The last part of this definition can be perceived as a law of agency as provided under Section 182 of the Indian Contract Act, 1872 which provides an agent as a person who is employed to represent another (principal) in dealings with a third person.
Therefore, by a bare reading of the definition of a partnership, we can list out the important ingredient of a partnership as:
- 1. It deals with the relationship with the partners and there should be more than one person for a partnership to be formed.
- 2. It arises out of a contract and the partners agree to share profits in agreed proportions.
- 3. The business will be carried on by all or any of them acting for all.
Section 4 also provides that persons who have entered into the partnership are called the partners and they are collectively constitute partnership firm.
Dissolution of partnership vs partnership firm
Before delving into dissolution of a partnership firm, it is important to bring out the difference between dissolution of a partnership firm and a partnership.
If the partnership firm is dissolved, the operation comes to a halt making and the relationship between the partners is terminated. In case of dissolution of partners, the existing agreement is terminated and a new partnership agreement is drawn.
Termination of a partnership may happen due to the following:
- 1. Introduction of a partner
- 2. Retirement of a partner
- 3. Expulsion of a partner
- 4. Insolvency of a partner
- 5. Changing in profit sharing
In Additional Commissioner of Income Tax V. Vinayak Cinema Hall (1977), an existing partnership was dissolved after the death of a partner and new partnership was formed to takeover the same operation. The new partnership firm had common partners with the earlier firm. The assessment officer considered this a reconstitution of partners and not a new partnership firm. The question before the court was whether two separate tax assessment was to be made or a tax assessment should be made considering it as a single entity.
The Andhra Pradesh HighCourt held that a separate assessment is to be considered only when there is absolute cessation of business operation and not when there is change in ownership as there is no change in personality of the business but a mere reconstitution. Hence, a single assessment of the firm was held valid.
Partners can dissolve a partnership while not dissolving the firm. Hence, dissolution of partnership results in alteration of the partnership agreement whereas, dissolution of a firm results in halting of business.
Dissolution of a Partnership Firm
Section 39 defines the dissolution of a firm as termination of partnership between all partners. After this, there will no fiduciary relationship between the partners and the firm undergoes a valuation and the accounts of the partners are settled according to Section 48 to Section 51 of the Act.
Dissolution of a partnership firm can happen in following ways:
I. Dissolution by an agreement (Section 40): A firm may be dissolved after all the partners consent to the dissolution or as stipulated in the partnership deed.
In Ramesh Kumar V. Smt. Latha Devi & Ors. (2007), The Madras High Court held that in absence of any contract between the partners and in absence of the same, the consent of all partners is compulsory.
II. Compulsory dissolution (Section 41): This section provides for compulsory dissolution if
a) All partners are adjudicated as insolvent or there is only one solvent partner.
b) If any event makes the operation of the business illegal to be carried on or for any partner or partners to carry on the business. However, if the firm carries on multiple businesses, the illegality of certain business does trigger dissolution of firm with respect to other lawful ventures.
In Prakash Chand V. Banwar Lal (2009),the Rajasthan High Court referring to Section 4 of the Act and the Supreme Court’s judgement in Erach F.D. Mehta V. Minoo F.D. Mehta (1970), held that if there are only two partners in a partnership firm and one of them retires, it will be unlawful according Section 41(b) for that firm to carry on further business as it becomes unlawful.
III. Dissolution on happening of certain contingencies (Section 42): A firm can be dissolved on happening of certain events like death of a partner, a partner becoming insolvent, if the tenure of the partnership deed comes to an end or if the partnership was formed with a purpose and it is dissolved after it has been achieved.
However, these contingencies are subject to the agreement between the partners. There can be an agreement between the partners that the partnerships shall continue even if one of them dies. In this case, the legal heir of the deceased cannot claim share unless it is provided that the legal heir shall inherit the share of the deceased. This is due to the fact that a partnership is created by a contract and not any law or regulation.
In Smt. Saroj Aggarwal V. Commissioner of Income Tax (1985), the Supreme Court held that even though there is no formal written contract, the courts must examine the circumstance and infer from the conduct of the parties for succession. The facts of the case are that after the death of the partner, his wife was inducted as the partner. It was contended that it was barred by Section 42(c) of the Act.
IV. Dissolution by notice of partnership at will (Section43): A partnership firm can be dissolved by a partner by giving notice of dissolution to other partners in writing.
If a partnership is stipulated for a specific time period and if it exceeds it, the partnership becomes a partnership at will. (Kirtikumar V. Dilipkumar (2013))
Right to dissolution is a legal right and no private arrangement can affect the same. Ant partner can dissolve a partnership by giving a notice.
In Hurst V. Bryk (2000), The house of lords held that where partners of the firm decide to dissolve the partnership firm, the sole dissenting partner cannot forego his obligation to share the liabilities of the firm.
V. Dissolution by court (Section 44): In some cases, the partners approach the court to dissolve the firm. The courts can dissolve partnership firms after careful consideration of the facts and circumstances for assessing the situation and render equitable justice.
According to this section, the courts can dissolve partnership firm on following grounds:
a) Unsound mind of partner: This section provides that this relief can be prayed by the next friend of the partner or other partners of the firm. For this, the partner who is allegedly unsound must not have a temporary or minor illness. It should of such magnitude that he must be unable to perform his duties and recovery from such illness must be remote.
b) The partner has become permanently incapable of performing his duties: If a partner becomes permanently incapable of performing his duties due to a disability or disease, the partners can pray for dissolution of the firm.
c) The partner is guilty of misconduct: If the conduct of a partner is affecting the working and operation of the business of the firm, it can be dissolved.
In Snow V. Milford (1868), it was held that if the misconduct is proved but the business or working of the partnership firm was not affected dissolution cannot be provided.
d) Willful breach of agreement:If the partner is willfully breaching the agreement consistently causing discomfort and disruption to the affairs of the firm which causes difficulty for other partners to conduct business, the partnership firm can be dissolved.
It should also be noted that the breach must not only be consistent and willful but should also be substantial such that it should affect the interest of the partners. A mere omission to perform cannot prima facie be ground for dissolution.
e) Transfer of his interest in the partnership: If the partner transfers his interest in the firm without the knowledge and consent of other partners to a third party or sold his interest towards any debt owed by him.
f) The partnership is running at a loss: If the partners believe that the firm cannot sustain losses anymore, the partnership firm was setup for a specific purpose or for a specified tenure cannot escape the scrutiny of the court.
g) On just and equitable grounds: The courts can grant relief of dissolution if it thinks fits on an equitable and just grounds. This discretion is conferred upon the court to provide it with wide scope to cover grounds not mentioned in clause a to f in this section.
In myriad of judgements both in India and England it is now settled that the words equitable and just are not be interpreted ejusdem generis. In Nagavarapu Krishna Prasad V. Andhra Bank Ltd. (2018), the Andhra Pradesh High Court referring to Hind Overseas Private Limited V. Raghunath Prasad Jhunjhunwala (1975) held that the just and equitable clause is wide in scope and it is the discretion of the courts to invoke this clause. The court also expressed its view that it is very difficult to define and constrain these words and it must be interpreted according to the facts and circumstances of the case. The only limitation upon this clause is itself, i.e., it should be invoked to render just and equitable judgement.
It also pointed out that the English courts tried to bring these words under a broad umbrella. One of the grounds was that dissolution or winding up can be ordered if the foundation of the partnership firm had faded away.
In M/s. National Non-Ferrous V. M/s. R.B. Patel &Co (2011)., the Supreme Court held that the power conferred under Section 44(g) of the Act is not exclusive to only courts but also to arbitral tribunals to dissolve a partnership firm.
It must also be made sure that while considering the ground of equitable and just grounds, it should be equitable to all partners and not only to the partner who is initiating the same.
Dissolution of a partnership and partnership is different. While the former terminates only the relationship between the partners, the latter terminates the existence of the partnership firm by discontinuing the operation of the firm. Section 39 of the Partnership Act defines dissolution of a partnership firm. A partnership firm can be dissolved by a court intervention under various grounds provided under Section 44. Whereas under Section 40 to Section 43 with the consent of the partners, the firm may be dissolved either due to an external happening of an incident or due to the acts of the existing partners.
Even after the dissolution of the firm, there are certain rights and obligations of the partners.
- The partners shall be personally liable to the third parties unless a notice of dissolution is made known to other parties.
- After the dissolution of the partnership firm, the partners can demand that the surplus from applying properties of the firm for settling any liability or debt to be shared among the partners in the agreed manner.
- Settlement of accounts between the partners according to Section 48 of the Act.
- The partners shall not use the name of the partnership firm for business purposes.
- The partners shall also agree that no similar business to that of the dissolved firm shall be conducted.