Dissolution of Partnership and Partnership Firm [Business Law Notes for BCOM NEP Syllabus]

A Partnership agreement is an agreement between two or more persons for carrying out various business activities. Reconstitution of a partnership refers to a situation when there is a change in the existing partnership agreement. In such a case, a new partnership agreement is formed to replace the old partnership agreement. It means the firm continues to exist and the only change will take place in existing partnership agreement.  Thus, reconstitution of a partnership takes place in each of the following cases:

a)       Change in profit sharing ratio

b)      Admission of a partner

c)       Retirement of a partner

d)      Death of a partner

e)      Amalgamation of two firms

a) Change in profit sharing ratio: Change in the profit-sharing ratio among the existing partners means the reconstitution of firm without the admission or retirement or death of a partner. In such case one or more partner acquires share of profit in the business from another partner due to which share of profit of acquiring partner’s increases and share of profit of sacrificing partners’ decreases. At the time of change in profit sharing ratio of existing partners’ assets and liabilities of a firm must be revalued because actual realizable value of assets and liabilities may be different from their book values. Change in the assets and liabilities to the period prior to change in profit sharing ratio and therefore it must be share in old profit sharing ratio.

b) Admission of a new partner: Admission of a partner is one of the modes of reconstitution of a partnership firm. In order to acquire additional capital and managerial skill, a new partner is admitted into the firm with the consent of old existing partners. This process is called admission of a partner. After admission of a partner, the firm is reconstituted and existing agreements comes to an end and new agreement among all the partners comes into effect. The new partner on joining becomes liable for the liabilities of the firm and entitled to assets and profits of the firm. A new partner may be admitted with the consent of all existing partners as per the provisions of the agreement of the firm. The new partner is entitled the following rights:

1.       The right to share in the assets of the partnership firm; and

2.       The right to share the profits in the business.

c) Retirement of an existing partner: A partner may withdraw himself from the partnership. This means that the old partnership agreement comes to an end and new partnership among the remaining partners, comes into existence. The exit or withdrawal of a partner is called retirement. As a result of retirement of a partner his relations with the firm are severed. A retiring partner remains liable for all the acts of the firm upto the date of his retirement. But if there is an agreement between the continuing partner and third party, the retiring partner may be discharged from his liability. If a public notice is not given by the retiring partner, then he will remain liable for all the acts of the firm after the retirement.

A partner may retire from the firm for various reasons such as old age, bad health, and strain relationship with other partners, financial problems, residence shifting or any other reasons. A partner may quit the firm with the consent of all the partners or when there is an express agreement to this effect or in case of partnership at will, by simply giving notice in writing to all other partners about his intention to retire.

The outgoing partner’s account is settled as per the terms of partnership deed i.e., in lump sum immediately or in various installments with or without interest as agreed or partly in cash immediately and partly in installment at the agreed intervals. In the absence of any agreement, Section 37 of the Indian Partnership Act, 1932 is applicable, which states that the outgoing partner has an option to receive either interest @ 6% p.a. till the date of payment or such share of profits which has been earned with his/her money (i.e., based on capital ratio). Hence, the total amount due to the retiring partner which is ascertained after all adjustments have been made is to be paid immediately to the retiring partner. In case the firm is not in a position to make the payment immediately, the amount due is transferred to the retiring Partner’s Loan Account, and as and when the amount is paid it is debited to his account.

d) Death of a partner: The death of a partner in partnership firm amounts to reconstitution of the firm since the vacant of one partner arises. Amount due to the deceased partner is calculated in the same way as in the case of retirement. Section 35 provides that where, under a contract between the partners, the firm is not dissolved by the death of a partner, and the estate of a deceased partner is not liable for any act of the firm done after his death.

e) Expulsion of a partner: Section 33 provides that a partner may not be expelled from a firm by any majority of the partners, save in the exercise, in good faith, of powers conferred by contract between the partners. The provisions of retired partners will be applicable to such expelled partner.

f) Insolvency of a partner: Section 34 provides that where a partner in a firm is adjudicated an insolvent, he ceases to be a partner on the date on which the order of adjudication is made, whether or not the firm is thereby dissolved. Where the firm is not dissolved by the adjudication of a partner as an insolvent, the estate of a partner so adjudicated is not liable for any act of the firm and the firm is not liable for any act of the insolvent, done after the date on which the order of adjudication is made.

Difference between dissolution of partnership and dissolution of firm

Basis of distinction	Dissolution of partnership	Dissolution of firm
Relationship	Relationship amongst all the partners does not come to an end.	Relationship amongst all the partners comes to an end.
Continuation of business	Business of the firm may continue.	Business of the firm does not continue.
Inter relationship	Dissolution of partnership may or may not result in dissolution of the firm.	Dissolution of the firm necessarily results in dissolution of partnership.
Books of accounts	Books of accounts are not closed.	Books of accounts are closed.
Nature	Dissolution of partnership is voluntary.	Dissolution of partnership may sometimes compulsory or sometimes voluntary.
Account	Revaluation account is prepared.	Realisation account is prepared.

Consequent to the dissolution of a partnership firm, the partners have certain rights and liabilities which are stated below:

1. Liability for acts of partners done after dissolution (Sec. 45): Section 45 provides that the liability of the partners will continue for the acts done before the dissolution, even after the dissolution, until public notice is given of the dissolution. The following partner is not liable for the acts after the date on which he ceases to be a partner:

a) A deceased partner.

b) Partner who is adjudicated as an insolvent.

c) A Partner who is not known to the parties dealing with the firm as a partner retires from the firm.

2. Right to share surplus after dissolution (Sec. 46): Section 46 provides that on the dissolution of a firm, every partner or his representative is entitled as against all the other partners or their representatives, to have the property of the firm applied in payment of the debts and liabilities of the firm and to have the surplus distributed among the partners or their representatives according to their rights.

3. Continuing authority of partners (Sec. 47): Section 47 provides that after the dissolution of a firm, the authority of each partner to bind the firm and the other mutual rights and obligations of the partners continue, notwithstanding the dissolution, so far as may be necessary to wind up the affairs of the firm and to complete transactions begun but unfinished at the time of the dissolution, but not otherwise.

4. Mode of settlement (Sec. 48):  Section 48 provides the mode of settlement of accounts between the partners after the dissolution. In this regard, the following shall be observed, subject to the agreements by the partners:

a) 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.

b) 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:

1. In paying the debts of the firm to the third parties.

2. In paying to each partner ratably what is due to him from the firm for advances as distinguished from capital.

3. In paying to each partner ratably what is due to him on account of capital; and

4. The residue, if any, shall be divided among the partners in the proportions in which they were entitled to share profits.

5. Payment of firm debts (Sec. 49):  Section 49 provides that 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 dues of the firm. 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 the payment of the debts of the firm.

6. Personal profits after dissolution (Sec. 50): Section 50 provides that the personal profits earned by any surviving partner or by the representatives of a deceased partner who carrying on the business of the firm, then such personal profits shall be accounted to the firm.

7. Return of premium of premature dissolution (Sec. 51): Section 51 provides that where a partner has paid a premium on entering into partnership for a fixed term and the firm is dissolved before the expiration of that term otherwise than by the death of the partner, such partner is entitled to repayment of the premium or of such part there of as may be reasonable.

8. Rescinding of contract (Sec.52): Section 52 provides that where a contract creating partnership is rescinded on the ground of the fraud or misrepresentation of any of the parties, the party entitled to rescind is, without prejudice to any other right, to be indemnified by the partner or partners guilty of the fraud or misrepresentation against all the debts of the firm.

9. Restrain to use firm name (Sec. 53): Section 53 provides that after a firm is dissolved, every partner or his representative may, in the absence of a contract between the partners to the contrary, restrain any other partner from carrying on a similar business in the firm name, or from using any of the property of the firm for his own benefit, until the affairs of the firm have been completely wound up.

10. Agreements in restraint of trade (Sec.54): Section 54 provides that partners may, upon or in anticipation of the dissolution of the firm, make an agreement that some or all of them will not carry on a business similar to that of them within a specified period of within the specified local limits, such agreement shall be valid if the restrictions imposed are reasonable.

11. Goodwill (Sec. 55): Section 55 provides that after the dissolution of a firm the goodwill shall be included in the assets and it be sold either separately or along with other property of the firm. Where the goodwill of the firm is sold a partner may carry on a business competing with that of the buyer and he may advertise such business, subject to agreement between him and the buyer, he may not:

a)       Use the firm name;

b)      Represent himself as carrying on the business of the firm; or

c)       Solicit the custom of persons who were dealing with the firm before its dissolution.

The liabilities of a partner on dissolution are as under:

(i) Liability for acts of partners done after dissolution: Until public notice of dissolution of the firm is given; partners continue to be liable to third parties for any act done by any of them. However, this liability does not apply to a partner who is dead or who is adjudged as insolvent or a sleeping partner.

(ii) Continuing authority of partners for purpose of winding up: After dissolution of a firm, the authority of each partner to bind the firm and the other mutual rights and obligations of the partners continue, so far as may be necessary:

(a) To wind up the affairs of the firm and

(b) To complete transactions began but unfinished, at the time of the dissolution.

(iii) Liability to share profits earned after dissolution: If any partner earns any profit from any transaction connected with the firm, after the dissolution, he must share it with the other partners and the legal representative of any deceased partner.