Partnership: Meaning, Characteristics, Merits and Limitations [Business Organisation and Management Notes NEP Syllabus]

Partnership is an association of two or more people who agreed to do business and share profits and losses arises from it in an agreed ratio. The partners act both as agents and principals of the firm.

In India, Partnership firm is governed by the Indian Partnership Act 1932. Section 4 of this act defines partnership as: "The relationship between persons, who have agreed to share the profits of a business carried on by all or any one of them acting for all."

According to Prof. Haney, partnership is "the relation between persons competent to make contract who agree to carry on a lawful business in common with a view to private gain."

Partnership in this way is an agreement, between two or more persons to carry on legal business with profit motive, which is carried on by all or any one of them acting for all.

Partners, Firm and Firm name: The persons who have entered into a partnership with one another are individually called partners and collectively a firm. The name under which the business is carried is called firm name.

Partnership has the following characteristics:

(i)        Agreement: Partnership is the result of an agreement, either written or oral, between two or more persons. An agreement between the partners may be expressed or implied. It arises from contract and not from status or process of law.

(ii)      Number of Persons: In a partnership firm there must be at least two people to form the business. Partnership Act 1932, does not specifies the maximum numbers of persons, but Section 464 of the Indian Companies Act 2013, restricts the number of Partners to 50 for a partnership firm. But in case of limited liability partnership there is no maximum limit.

(iii)    Profit-Sharing: The agreement between/among partners must be to share profit or losses. Sharing of profit is an essential feature of partnership. But an agreement to share losses is not an essential element. There may be specific provision in the partnership deed that a particular partner or partners shall not bear the losses.

(iv)    Business: The existence of business is essential in case of partnership. The term business includes every trade, occupation and profession.  Also the motive of the business is the acquisition of gain which leads to the formation of partnership. If there is no intention to carry on the business and to share the profit thereof, there can be no partnership.

(v)      Business carried on by all or any of them acting for all: Business must be carried on by all the partners or any one of them acting as agent of other partners. Each partner carrying on the business is the principle as well as the agent for all the other partners. Any act of one partner in the course of the business of the firm is in fact an act of all the partners. This relationship between the partners is the true test of partnership.

(vi)    Motive: For a partnership firm there must be motive to earn profit. A partnership firm cannot be formed with service motive.

(vi) Legality of the Business: The business to be carried on by the partners must be legal. There should be lawful consideration and the business should not be illegal in the eyes of law.

Merits of Partnership Form of Business Organisation

1. Easy to Form: A partnership can be formed easily without many legal formalities. Since it is not compulsory to get the firm registered, a simple agreement, either in oral, writing or implied is sufficient to create a partnership firm.

2. Availability of Larger Resources: Since two or more partners join hands to start partnership firm it may be possible to pool more resources as compared to sole proprietorship form of business organisation.

3. Better Decisions: In partnership firm each partner has a right to take part in the management of the business. All major decisions are taken in consultation with and with the consent of all partners. Thus, collective wisdom prevails and there is less scope for reckless and hasty decisions.

4. Flexibility: The partnership firm is a flexible organisation. At any time, the partners can decide to change the size or nature of business or area of its operation after taking the necessary consent of all the partners.

5. Sharing of Risks: The losses of the firm are shared by all the partners equally or as per the agreed ratio.

6. Keen Interest: Since partners share the profit and bear the losses, they take keen interest in the affairs of the business.

7. Benefits of Specialisation: All partners actively participate in the business as per their specialisation and knowledge. In a partnership firm providing legal consultancy to people, one partner may deal with civil cases, one in criminal cases, another in labour cases and so on as per their area of specialisation. Similarly, two or more doctors of different specialisation may start a clinic in partnership.

8. Protection of Interest: In partnership form of business organisation, the rights of each partner and his/her interests are fully protected. If a partner is dissatisfied with any decision, he can ask for dissolution of the firm or can withdraw from the partnership.

9. Secrecy: Business secrets of the firm are only known to the partners. It is not required to disclose any information to the outsiders. It is also not mandatory to publish the annual accounts of the firm.

Limitations of Partnership Form of Business Organisation

A partnership firm also suffers from certain limitations. These are as follows:

1. Unlimited Liability: The most important drawback of partnership firm is that the liability of the partners is unlimited i.e., the partners are personally liable for the debt and obligations of the firm. In other words, their personal property can also be utilised for payment of firm’s liabilities.

2. Continuity Concerns: A partnership's continuity can be disrupted if a partner decides to leave, potentially requiring a re-evaluation of the business.

3. Limited Capital: Since the total number of partners cannot exceed 20, the capacity to raise funds remains limited as compared to a joint stock company where there is no limit on the number of shareholders.

4. Non-transferability of share: The share of interest of any partner cannot be transferred to other partners or to the outsiders. So it creates inconvenience for the partner who wants to transfer his share to others fully or partly. The only alternative is dissolution of the firm.

5. Possibility of Conflicts: We know that in partnership firm every partner has an equal right to participate in the management. Also every partner can place his or her opinion or viewpoint before the management regarding any matter at any time. Because of this, sometimes there is friction and quarrel among the partners. Difference of opinion may give rise to quarrels and lead to dissolution of the firm.

6. Inequality in Contributions: Partners might contribute unequally in terms of effort, leading to feelings of unfairness.

Different types of Partnership: The following are the different types of Partnership:

1) General Partnership: In a general partnership, the liability of each partner is unlimited. It means that the firm’s creditors can realize their dues in full from any of the partners by attaching their personal property if the firm’s assets are found to be inadequate to pay off its debts. An exception is made in the case of a minor partner whose liability is limited to the amount of his share in the capital and profits of the firm. In India all partnership firms are general partnerships. Each partner of a general partnership is entitled to take active part in the management of the firm, unless otherwise decided by the other partners.

2) Limited partnership: A limited partnership is a partnership consisting of some partners whose liability is limited to the amount of capital contributed by each. The personal property of a limited partner is not liable for the firm’s debts. He cannot take part in the management of the firm. His retirement, insolvency, lunacy or death does not cause dissolution of the firm. There is at least one partner having unlimited liability. A limited partnership must be registered. Limited partnership is now allowed in India under the Limited Liability Partnership Act. In England limited partnership can be formed under the Limited Partnership Act, 1907 and in the USA under the Partnership Act, 1890.

3) Particular Partnership: Where two or more persons agree to do a business in a particular adventure or undertaking such a partnership is called a ‘particular partnership’. For example: A and B enter into a partnership for producing of film.

4) Partnership-at-will: When no provision is made by the contract between the partners for the duration of the partnership or for the determination of the partnership, the partnership is called partnership-at-will. The partnership-at-will has no fixed or definite date of termination and therefore death or retirement of any of the partner does not affect the existence of the partnership. A partnership-at-will can be dissolved by any partner by giving notice in writing to all the remaining partners about the intention of such dissolution.

Different Types of Partners: The different types of Partners are:

(i) Active Partner: A person who is actively, actually or effectively engaged in the conduct of business of the partnership firm is known as an Active Partner. He is the agent of the other partners and has authority to bind the firm and the other partners in the ordinary course of business.

(ii) Sleeping or Dormant Partner: A sleeping partner is one who does not take an active part in the conduct of business of the firm. He invests capital and shares the profits of the firm and is also equally liable along with other partners for all the liabilities of the firm.

(iii) Nominal Partner: A person who lends his name to the firm, without having any real interest in it is called a Nominal Partner. He does not invest any capital in the business nor does he takes any active part in the business nor does he share any profit of the firm. However, he is liable along with other partners for all the liabilities of the firm.

(iv) Partner in Profit only: Where a partner agrees with the other partners that he shall share only profits and shall not be liable for any losses of the firm he is called Partner in Profit only. However, he remains liable to the creditors for the debts of the firm since under the Partnership Act the liabilities of the partners are joint, several and unlimited.

(v) Sub-Partner: Where a partner agrees to share his profits earned form the firm with a third person then that third person is known as the sub-partner. A sub-partner has no rights against the firm and cannot represent himself as a partner of the firm. He is in no way connected with the firm and is thus not liable for the liabilities of the firm.

(vi) Partner by Estoppel or by Holding Out: Sometimes strangers represent themselves to be partners in a firm and thereby induce third parties to give credits to the firm such strangers are called as partners by Estoppel or Partners by Holding Out. Section 28 of the Partnership Act prescribes that a person be liable as a partner by Holding out must fulfill the following condition:

(a) He must have by words, written or spoken or by his conduct, represented himself to be a partner or

(b) He must have knowingly permitted himself to be represented as a partner to the other person and

(c) The other person must have acted on the faith of such representation and have given credit to the firm.

(vii) Minor Partner: As per Section 11 of the Indian Contract Act, 1872 a minor cannot enter into an agreement. However, Section 30 of the Partnership Act provides that with the consent of all the partners for the time being a minor may be admitted to the benefits of Partnership.