Definition and Formation of Partnership

Definition of Partnership (Section 4)

The law relating to partnership firms in India is governed by the Indian Partnership Act, 1932. This Act defines what a partnership is and the rights and duties of partners. The core definition is provided in Section 4.

Definition under Section 4

Section 4 defines "Partnership", "Partner", "Firm", and "Firm Name":

"'Partnership' is the relation between persons who have agreed to share the profits of a business carried on by all or any of them acting for all."

"Persons who have entered into partnership with one another are called individually 'partners' and collectively a 'firm', and the name under which their business is carried on is called the 'firm name'."

Explanation:

Relation between persons: Partnership is a relationship between individuals. There must be at least two persons (and generally not exceeding a certain number as per Companies Act restrictions on partnerships) to form a partnership. The persons must be competent to contract.
Agreed to share profits: The persons must have entered into an agreement with the objective of sharing the profits of a business.
Of a business: There must be a 'business' involved. Section 2(b) defines "business" as including "every trade, occupation, and profession". So, partnership is formed for carrying on some economic activity. Joint ownership of property (e.g., co-owners of a house) does not, by itself, constitute a partnership unless they are carrying on a business with that property and sharing profits.

Business carried on by all or any of them acting for all

This phrase encapsulates the principle of Mutual Agency, which is considered the cornerstone or true test of partnership. It means that:

The business can be carried on by all the partners together, or by some of the partners on behalf of all the partners.
Any partner acting within the scope of the firm's business is acting as an agent for all the other partners, and their actions can bind the firm and the other partners.
Conversely, each partner is also a principal, being bound by the acts of the other partners.

This mutual agency distinguishes partnership from mere joint ownership or profit sharing. The ability of one partner to bind the others by their actions in the firm's business is unique to partnership.

Example: A and B agree to share profits of a trading business. A buys goods for the business. A is acting on behalf of himself and B. B is bound by A's act of buying goods for the firm's business.

Example 1. Mr. X and Mr. Y jointly own a property and decide to rent it out, agreeing to share the rental income equally. Are they partners?

Answer:

No, Mr. X and Mr. Y are generally not partners merely by jointly owning and renting out a property and sharing rental income. While there are persons, an agreement to share income (which might be considered profit) from a property does not automatically create a partnership. For a partnership to exist, there must be a 'business' in the sense of carrying on a trade, occupation, or profession with an element of continuity, and crucially, the business must be carried on by all or any of them acting for all (mutual agency). Joint ownership and sharing of income from passive investment in property usually lacks the element of actively carrying on a business and mutual agency. They are likely co-owners, not partners, unless they engage in extensive property management activities together, which would constitute carrying on a business.

Essentials of Partnership

Based on the definition in Section 4 and other provisions of the Act, the following are the essential elements that must be present for a partnership to exist:

Agreement

Partnership arises from a contract, not from status (like the relationship between members of a Hindu Undivided Family - Section 5). There must be an agreement between the persons to enter into a partnership. This agreement can be express (written or oral) or implied from the conduct of the parties and their course of dealing.

The agreement must be among two or more persons who are competent to contract (Section 11, Indian Contract Act applies). They must agree on the terms of the partnership, although these can be modified later by mutual consent.

Business

There must be a 'business' to be carried on. Business includes any trade, occupation, or profession (Section 2(b)). The object of the agreement must be to carry on some form of economic activity. An agreement to carry on a non-economic activity or a social venture does not constitute a partnership under the Act.

Example: Persons jointly undertaking a social welfare project without the objective of profit from that activity are not partners, even if they contribute resources.

Mutual Agency

This is the 'business carried on by all or any of them acting for all' aspect from Section 4. Mutual agency is the ultimate test for determining the existence of a partnership (as confirmed by the Supreme Court in cases like K.D. Kamath & Co. v. Commissioner of Income Tax). It means that each partner is both a principal and an agent for the other partners in the conduct of the partnership business. The act of one partner, done within the scope of the firm's business, binds the firm and all other partners.

While sharing of profits is important evidence of partnership, mutual agency is decisive. A person may share profits without being a partner (e.g., an employee receiving a share of profits as remuneration, a lender receiving interest contingent on profits, a widow of a deceased partner receiving annuity from profits). However, if mutual agency exists, it is strong evidence of partnership, even if profit-sharing terms are complex.

Sharing of Profits

The agreement must be to share the profits of the business. While sharing of profits is strong *prima facie* evidence of partnership (Section 6), it is not conclusive proof. As mentioned, other relationships might involve sharing of profits without creating a partnership. The crucial element, when examining profit sharing, is whether the person receiving a share of profits is doing so as a return on an investment in the business coupled with mutual agency, or in some other capacity (like employee or lender).

The partners need not necessarily share losses, although agreements to share profits usually imply an agreement to share losses too, unless specifically excluded. An agreement to share losses alone, without profit sharing, does not create a partnership.

Legal Relationship (Section 5)

Section 5 clarifies that "The relation of partnership arises from contract and not from status". This emphasizes that partnership is a voluntary contractual relationship. While registration of a firm is optional (Section 58), an unregistered firm suffers certain disabilities (Section 69), but the partnership itself comes into existence based on the agreement and the fulfilment of the essentials, regardless of registration.

Example 1. Mr. A, a financier, lends money to Mr. B, who runs a business, on the condition that Mr. A will receive, in addition to interest, 10% of the net profits of Mr. B's business. Mr. A has no involvement in managing the business and cannot bind Mr. B by any of his actions. Are Mr. A and Mr. B partners?

Answer:

No, Mr. A and Mr. B are not partners. While there are persons, an agreement, and sharing of profits, the crucial element of Mutual Agency is missing. Mr. A is merely a lender receiving a share of profits as part of the return on his loan; he is not carrying on the business with Mr. B or acting as Mr. B's agent, nor can he bind Mr. B. The relation is that of a lender and borrower, not partners. Sharing of profits alone is not conclusive proof of partnership if mutual agency is absent (Section 6).

Distinction between Partnership and Company

Partnership firms and companies are both forms of business organizations, but they are fundamentally different in their legal nature and structure. The Companies Act, 2013 governs companies, while the Indian Partnership Act, 1932 governs partnerships.

Comparison Table: Partnership vs. Company

Basis	Partnership Firm	Company (Public/Private)
Legal Status	Generally has no separate legal entity distinct from its partners. The firm name is a collective name for the partners.	Is a separate legal entity distinct from its members (shareholders). Has perpetual succession.
Governing Law	Indian Partnership Act, 1932.	Companies Act, 2013.
Creation	Created by an agreement between persons. Registration is optional.	Created by registration under the Companies Act, 2013.
Members/Partners	Called Partners.	Called Members or Shareholders.
Number of Members/Partners	Minimum 2. Maximum generally limited by the Companies Act (currently 50 for partnerships carrying on business not restricted by any other law).	Private Company: Minimum 2, Maximum 200. Public Company: Minimum 7, No maximum.
Liability	Liability of partners is generally unlimited and joint and several. Each partner is personally liable for the debts of the firm. (Limited Liability Partnership - LLP - is a hybrid form with limited liability).	Liability of members is generally limited to the unpaid value of shares held by them or guarantee given.
Management	Business is carried on by all or any of the partners acting for all (Mutual Agency). Partners generally have the right to participate in management.	Managed by a Board of Directors elected by members. Members generally do not have direct participation in day-to-day management.
Transfer of Interest	A partner cannot transfer their interest in the firm to an outsider without the consent of all other partners (Section 29).	Shares (interest) are generally freely transferable (subject to restrictions in private companies' articles).
Duration	Partnership can be for a fixed period or at will. Termination by death, insolvency, etc., of a partner unless contract provides otherwise (Section 42).	Has perpetual succession. Existence is not affected by death, insolvency, or transfer of shares of members.
Audit	Audit is generally not compulsory under the Partnership Act (may be required under Income Tax Act or other specific laws).	Audit is compulsory under the Companies Act.
Profit Distribution	Profits are shared among partners as per the partnership agreement.	Profits are distributed as Dividends to shareholders (if declared by directors).

The key distinctions lie in legal personality, liability, and transferability of interest. LLPs, governed by the Limited Liability Partnership Act, 2008, offer features of both, providing limited liability while retaining flexibility of internal management akin to a partnership.

Example 1. A group of 5 friends starts a small business manufacturing and selling handicrafts. They contribute capital, agree to share profits and losses equally, and all participate in managing the business, with each having authority to buy materials on behalf of the business. They do not register their business as a company. What form of business organization is this, and what is the key implication regarding their liability?

Answer:

This is likely a Partnership Firm. It has the essential elements: persons entering into an agreement to carry on a business, sharing profits, and importantly, the business is carried on by all of them with mutual agency (each having authority to bind the others). Since they haven't registered as a company, it operates as a partnership under the Indian Partnership Act. The key implication regarding their liability is that their liability for the debts and obligations of the firm is generally unlimited and joint and several. If the business incurs debts, creditors can recover not only from the assets of the firm but also from the personal assets of each partner, potentially compelling any one partner to pay the entire debt (who can then seek contribution from others).

Minor as a Partner

As discussed under the Capacity to Contract (Section 11, Indian Contract Act), a minor is not competent to enter into a contract, and an agreement with a minor is void ab initio. Since partnership arises from a contract (Section 5, Partnership Act), a minor cannot be a full-fledged partner in a firm.

Rule regarding Minor in Partnership (Section 30)

Section 30(1) of the Indian Partnership Act, 1932 provides a special provision regarding the admission of a minor to the benefits of partnership:

"A person who is a minor according to the law to which he is subject may not be a partner in a firm, but, with the consent of all the partners for the time being, he may be admitted to the benefits of partnership."

Explanation:

Cannot be a Partner: A minor cannot become a partner in the full sense, undertaking the liabilities and having the full rights of a partner.
Admission to Benefits: With the consent of all existing partners, a minor can be admitted to the *benefits* of the partnership. This means the minor can share in the profits and assets of the firm but is generally not subject to the liabilities.

Position of a Minor Admitted to Benefits:

Rights:
- Right to share in the profits and property of the firm as per the agreement.
- Right to have access to and inspect the accounts of the firm.
- Right to sue the partners for his share of the property and profits if he is wrongfully excluded from the benefits (but only if severing his connection with the firm).
Liabilities:
- His liability is limited to his share in the property and profits of the firm. He is not personally liable for the debts or obligations of the firm. His personal assets outside his share in the firm cannot be used to satisfy firm debts.
- He cannot be sued directly by the creditors of the firm.

This limited status continues during his minority. When the minor attains the age of majority (18 or 21 years, as applicable), he has a crucial decision to make (Section 30(5)):

Within six months of attaining majority or obtaining knowledge that he has been admitted to the benefits of partnership (whichever date is later), the minor must give public notice whether he elects to become a partner or not.

If he elects to become a partner: He becomes a full partner from the date he was admitted to the benefits. His share and rights will be the same as he was enjoying as a minor, but his liability becomes unlimited from the date of the public notice.
If he elects not to become a partner (or fails to give notice): He is discharged from all liability for acts of the firm done after the date of the public notice. His share is not liable for acts done after that date. He is entitled to sue the partners for his share of the property and profits.

If he fails to give notice within the six months, he is deemed to have elected to become a partner from the date of expiry of the six months, and his liability becomes unlimited from that date.

Example 1. Mr. Piyush, a minor, is admitted to the benefits of a partnership firm with the consent of all existing partners. The firm incurs a debt of Rs. 10 Lakhs. The assets of the firm are only Rs. 6 Lakhs. Can the creditors recover the remaining Rs. 4 Lakhs from Mr. Piyush's personal property (like his inherited savings)?

Answer:

No, the creditors cannot recover the remaining amount from Mr. Piyush's personal property. As a minor admitted only to the benefits of partnership, his liability is limited to his share in the property and profits of the firm (Section 30(3)). He is not personally liable for the debts of the firm. The creditors can recover from the firm's assets (Rs. 6 Lakhs) and from the personal assets of the other adult partners (whose liability is unlimited), but not from Mr. Piyush's personal savings outside his share in the firm.

Rights, Duties, and Liabilities of Partners**

Rights of Partners

The Indian Partnership Act, 1932, provides various rights to partners, which define their entitlements within the firm and in relation to other partners. These rights are typically subject to any agreement between the partners.

Rule under Section 12 (Subject to contract between partners)

Section 12 of the Indian Partnership Act, 1932 outlines the mutual rights and duties of partners, subject to a contract between the partners. This means the partnership deed or agreement can modify or exclude these default rights and duties.

Section 12(a): Subject to contract between the partners—

"Every partner has a right to take part in the conduct of the business;"

Right to take part in conduct of business

Unless the partnership agreement provides otherwise, every partner has the right to participate in the management and operation of the firm's business. This reflects the principle of mutual agency where all partners are involved in carrying on the business.

Example: In a trading firm, every partner has the right to participate in decisions about purchasing, selling, staffing, etc.

However, the partners can agree to delegate management responsibilities to specific partners or a managing committee, thereby restricting the active participation of others.

Right to access books and accounts

Section 12(d): Subject to contract between the partners—

"Every partner has a right to have access to and to inspect and copy any of the books of the firm."

Explanation:

Every partner is entitled to see all the financial records, accounts, and other books of the firm.
They also have the right to make copies of these documents.
This right is provided to enable partners to keep track of the firm's financial position and the conduct of the business. This right is absolute and cannot be denied, although the partnership agreement might specify the procedure or timing for inspection.

Other Rights of Partners (Subject to contract between partners):

Right to be consulted (Section 12(c)): In case of differences regarding ordinary matters connected with the business, the decision is to be taken by the majority of partners, and every partner has the right to express their opinion before the matter is decided. For changes in the nature of the business, the consent of all partners is required.
Right to share profits (Section 13(b)): Partners are entitled to share equally in the profits earned and shall contribute equally to the losses sustained by the firm. This applies if the profit-sharing ratio is not specified in the agreement.
Right to receive interest on capital (Section 13(c)): A partner is not generally entitled to receive interest on the capital contributed by him. Interest on capital is payable only if the partnership deed expressly provides for it or it is customary.
Right to receive interest on advances (Section 13(d)): A partner is entitled to receive interest at the rate of six percent per annum on the advances made by him to the firm beyond the amount of capital he agreed to subscribe.
Right to be indemnified (Section 13(e)): Every partner has a right to be indemnified by the firm for expenses properly incurred by him in the course of the firm's business, or in doing any act for the preservation of the property or business of the firm in an emergency.
Right not to be expelled (Section 33): A partner cannot be expelled from the firm by a majority of partners unless the power to expel has been conferred by contract between the partners and has been exercised in good faith for the benefit of the firm.
Right to retire (Section 32): A partner has a right to retire as per the agreement, or with the consent of all other partners, or where the partnership is 'at will', by giving notice.
Right to dissolve the firm (Section 40-44): Partners have the right to dissolve the firm under various circumstances, including by agreement, compulsory dissolution, dissolution on the happening of certain contingencies, by notice (in partnership at will), or by court order.

All these rights can be modified or excluded by the partnership agreement, except the right to dissolve by court and the right to access books (which is fundamental for accounting). However, even the latter can be regulated.

Example 1. In a partnership firm with three partners, Mr. A, Mr. B, and Mr. C, the partnership deed states that only Mr. A will be responsible for managing the day-to-day business. Do Mr. B and Mr. C still have a right to participate in the conduct of the business?

Answer:

No, Mr. B and Mr. C generally do not have the right to participate in the day-to-day conduct of the business in this case. While Section 12(a) provides every partner with the right to take part, this right is "subject to contract between the partners". Since the partnership deed (the contract between the partners) restricts the management responsibility to Mr. A, this express agreement overrides the default right under Section 12(a). Mr. B and Mr. C have contractually agreed not to exercise this right.

Duties of Partners

Partners, in their relationship with each other and with the firm, owe certain duties. These duties are largely based on the fiduciary nature of the partnership relationship, requiring partners to act honestly and in the best interest of the firm and other partners.

Duty to carry on business to the greatest common advantage (Section 9)

Section 9: General duties of partners

"Partners are bound to carry on the business of the firm to the greatest common advantage, to be just and faithful to each other, and to render true accounts and full information of all things affecting the firm to any partner or his legal representative."

Explanation:

Partners must conduct the firm's business with the objective of maximizing benefit for the partnership as a whole, not just for their personal gain.
They must act honestly and diligently in the interest of the firm.

Duty to be faithful to each other (Section 9)

This is also part of Section 9. The relationship between partners is one of utmost good faith (*uberrimae fidei*). Partners are fiduciaries for each other. They must act honestly, openly, and transparently in their dealings related to the partnership. They should not take unfair advantage of their co-partners.

Duty to render accounts (Section 9)

This is also included in Section 9. Partners have a duty to maintain true accounts of the firm's business and provide full and accurate information regarding the firm's affairs to any other partner or their legal representative upon request. This duty ensures transparency and accountability among partners.

Duty to indemnify for loss caused by misconduct (Section 13(f))

Section 13(f): Subject to contract between the partners—

"A partner shall indemnify the firm for any loss caused to it by his wilful neglect in the conduct of the business of the firm."

Explanation:

If a partner's negligence or misconduct (deliberate or reckless act/omission) causes a loss to the partnership firm, that partner is liable to compensate (indemnify) the firm for that loss.
This encourages partners to act carefully and responsibly in the firm's business.

Other Duties of Partners (Subject to contract between partners):

Duty to attend diligently (Section 12(b)): Every partner is bound to attend diligently to their duties in the conduct of the business.
Duty not to compete with the firm (Section 11(2), 16(b)): A partner must not carry on any business similar to or competing with that of the firm (Section 11(2)). If a partner carries on a competing business and derives profits, they must account for those profits to the firm (Section 16(b)). This duty applies as long as they are partners.
Duty to account for profits derived from transactions with the firm or from use of firm property (Section 16(a)): If a partner derives any profit for himself from any transaction of the firm, or from the use of the property or business connection of the firm or the firm name, he must account for that profit to the firm.
Duty to hold property of the firm and use it for firm purposes.

Example 1. Mr. Usman, a partner in a trading firm, uses the firm's money to invest in shares for his personal account without informing the other partners. He makes a profit of Rs. 50,000/- from these investments. Is he obligated to share this profit with the firm?

Answer:

Yes, Mr. Usman is obligated to account for and pay this profit to the firm. He used the firm's money (property) for his personal benefit and derived a profit from a transaction connected with the firm's resources, without informing the other partners. According to Section 16(a), if a partner derives any profit for himself from the use of the property or business connection of the firm, he must account for that profit to the firm. He also failed in his duty to be faithful and render full information (Section 9).

Liabilities of Partners

Partnership involves mutual agency, which means that the actions of one partner, done within the scope of their authority, can create liabilities for the firm and all other partners. The liability of partners is a crucial aspect of partnership law.

Liability for acts of the firm (Section 25)

Section 25: Liability of a partner for acts of the firm

"Every partner is liable, jointly and severally, for all acts of the firm done while he is a partner."

Explanation:

Joint and Several Liability: This is the general rule regarding the liability of partners for the firm's debts and obligations. 'Joint' means that all partners together are liable. 'Severally' means that each partner individually is liable for the entire debt.
Act of the Firm: Refers to any act or omission by all the partners, or by a partner or agent of the firm acting in the name of the firm or with the authority of the firm, which gives rise to a right enforceable by or against the firm (Section 2(a)).
Done while he is a Partner: A partner is liable only for the acts of the firm done while they were a partner. They are not generally liable for acts done before they joined or after they left (though liability of retiring partners requires specific notice).

If a firm owes money to a creditor, the creditor can sue all the partners jointly, or choose to sue any one of the partners individually for the full amount. The partner who is compelled to pay the entire debt can then claim contribution from the other partners based on their internal agreement.

Example: A, B, and C are partners. The firm takes a loan of Rs. 15 Lakhs. If the firm fails to repay, the bank can sue A, B, and C jointly, or sue A alone for Rs. 15 Lakhs, or B alone for Rs. 15 Lakhs, or C alone for Rs. 15 Lakhs, or any combination. If A pays the whole amount, he can recover his share from B and C as per their partnership agreement.

This unlimited and joint and several liability is a key characteristic of traditional partnerships, making it risky for partners, particularly for large debts.

Liability for new partner

Section 30(7), relating to a minor admitted to benefits who becomes a partner upon attaining majority, states:

"(a) if he becomes a partner, his rights and liabilities as a minor continue up to the date on which he becomes a partner, but he also becomes personally liable to third parties for all acts of the firm done since he was admitted to the benefits of partnership, and" (rest of clause deals with his share).

This applies specifically to a minor partner. When a minor who was admitted to benefits becomes a full partner upon attaining majority, his liability for the firm's acts done *since his admission to benefits* becomes unlimited. This is an exception to the general rule that an incoming partner is not liable for past acts of the firm. The reason is that the minor was already deriving benefits from those past acts.

For other incoming partners (adults): Section 31(2) states:

"A person who is introduced as a partner into an existing firm does not thereby become liable for any act of the firm done before he became a partner."

Explanation: An incoming partner is generally not liable for the debts or obligations of the firm that arose before they joined the partnership, unless they expressly agree to take on such liability (e.g., in the agreement by which they are admitted). This is the general rule for adult incoming partners.

Liability for acts of partners to third parties (Section 26, 27, 28)

Sections 26, 27, and 28 deal with the authority of partners to bind the firm and the liability arising from partners' actions towards third parties.

Section 26: Liability of the firm for act of a partner
"Subject to the provisions of Section 27, the act of a partner which is done to carry on, in the usual way, business of the kind carried on by the firm, binds the firm."
This section embodies the principle of implied authority of a partner (Section 19 - implied authority). Any act done by a partner in the usual course of the firm's business of that kind binds the firm and all other partners, even if the partner acted without actual authority or against internal restrictions, provided the third party dealt with the partner in good faith and without knowledge of the lack of authority.
Section 27: Partner's authority in an emergency (This section number is incorrect in the prompt/my knowledge - Section 27 actually discusses the effect of admission that partner makes. Section 19(2) lists implied authority). Let's refer to actual Section 27: Section 27: Effect of admissions by a partner - "An admission or representation made by a partner concerning the affairs of the firm is evidence against the firm, if it is made in the ordinary course of business." This makes certain statements by partners binding on the firm. Section 28 deals with effect of notice to partner.
Section 28: Effect of notice to act partner - "Notice to a partner who habitually acts in the business of the firm of any matter relating to the affairs of the firm operates as notice to the firm, except in the case of a fraud on the firm committed by or with the consent of that partner." Knowledge of a working partner is generally imputed to the firm.

The 'act of the firm' (for which partners are liable under Section 25) often arises from the actions of individual partners acting within their actual (express or implied) or apparent authority.

Liability of firm for wrongful acts of a partner (Section 26 - again, this section number is likely referring to a concept, not the section itself; Section 26 deals with partner's liability for acts of firm. The relevant section for wrongful acts of partner is Section 10 of the Partnership Act).

Section 10: Duty to indemnify for loss caused by fraud or wilful neglect - While Section 13(f) is duty to indemnify the *firm*, Section 10 makes the partner liable to the firm for fraud or wilful neglect.

Section 26: Liability of the firm for wrongful acts or omissions of a partner (This is the correct section, it should be Section 26 for Liability of Firm for Wrongful Acts)

"Where, by the wrongful act or omission of a partner acting in the ordinary course of the business of a firm, or with the authority of his partners, loss or injury is caused to any third party, or any penalty is incurred, the firm is liable therefor to the same extent as the partner."

Explanation:

If a partner commits a tort (wrongful act) or omission (e.g., negligence, defamation, trespass, fraud) while acting within the ordinary course of the firm's business, the firm is liable to the third party for the loss or injury caused.
The liability of the partners is joint and several for such wrongful acts committed by a partner in the course of business.

Example: A, a partner in a law firm, while handling a client's case in the ordinary course of the firm's business, acts negligently, causing financial loss to the client. The client can sue the law firm (and thereby all partners) for damages caused by A's professional negligence.

Liability of firm for misapplication of property by a partner (Section 27 - this section number is also likely referencing a concept, the relevant section for misapplication of property by a partner is Section 27)

Section 27: Liability of firm for misapplication by partners (This is the correct section, it should be Section 27 for Liability of Firm for Misapplication)

"Where—

(a) a partner acting within his apparent authority receives money or property from a third party and misapplies it, or

(b) a firm in the course of its business receives money or property from a third party, and the money or property is misapplied by any of the partners while it is in the custody of the firm,

the firm is liable to make good the loss."

Explanation:

This section deals with situations where money or property entrusted to the firm or a partner for firm purposes is misused or misappropriated.
If a partner receives money/property from a third party while appearing to act for the firm, and misapplies it, the firm is liable.
If the firm, in the course of its business, receives money/property, and a partner misapplies it while it's with the firm, the firm is liable.

Example: A, a partner in a firm of solicitors, receives money from a client to be invested on the client's behalf. A misapplies the money. The firm is liable to the client for the misapplied money.

Example: Goods are left with a firm of warehousemen in the course of their business. One partner of the firm misapplies the goods. The firm is liable.

These sections (26 and 27) reinforce the principle that because each partner is an agent for the firm, the firm (and thus all partners) is liable for wrongful acts or misapplication of funds committed by a partner acting within the scope of the partnership business or with the authority of the firm.

Example 1. Mr. Vinay, a partner in a manufacturing firm, enters into a contract to buy raw materials on behalf of the firm. He acts within his usual authority as a partner. The firm fails to pay the supplier for the raw materials. Can the supplier sue only Mr. Vinay for the entire amount?

Answer:

Yes, the supplier can sue only Mr. Vinay for the entire amount. Mr. Vinay, acting as a partner in the ordinary course of the firm's business, entered into the contract, which is considered an act of the firm. According to Section 25, every partner is liable, jointly and severally, for all acts of the firm done while he is a partner. The supplier can choose to sue all partners jointly, or any one partner (like Mr. Vinay) severally for the full debt. If Mr. Vinay pays the full amount, he can claim contribution from the other partners.

Example 2. Mr. Zubin, a partner in a firm of chartered accountants, while handling a client's tax matters for the firm, gives incorrect advice due to gross negligence, causing the client to incur a significant penalty from the Income Tax department. Is the firm liable to the client for the loss?

Answer:

Yes, the firm is liable to the client for the loss. Mr. Zubin's act of giving incorrect advice due to negligence is a wrongful act (a tort - professional negligence). This act was committed while acting in the ordinary course of the firm's business (handling the client's tax matters). According to Section 26 (Liability of firm for wrongful acts), where a partner, acting in the ordinary course of business, causes loss or injury to a third party by a wrongful act or omission, the firm is liable. The client can sue the firm (and thereby all partners, who are jointly and severally liable) to recover the amount of the penalty and any other direct losses caused by Mr. Zubin's negligence.

Dissolution of Partnership**

Modes of Dissolution

The term Dissolution of Partnership refers to the breaking or termination of the relationship between all the partners of a firm. When the relationship between all partners comes to an end, the firm is dissolved. It is important to distinguish this from dissolution of the firm, which involves the winding up of the firm's business. The Indian Partnership Act, 1932, provides various ways in which a firm can be dissolved (Sections 39 to 44).

Section 39: Dissolution of a firm

"The dissolution of a partnership between all the partners of a firm is called the 'dissolution of the firm'."

The Act specifies several modes of dissolution:

Dissolution by agreement (Section 40)

Section 40:

"A firm may be dissolved with the consent of all the partners or in accordance with a contract between the partners."

Explanation:

Partnership arises from an agreement, so it can also be dissolved by a fresh agreement among all the partners.
The partnership agreement itself may contain clauses specifying how and when the firm can be dissolved (e.g., dissolution after a certain period, or upon the happening of a specific event). Dissolution can occur in accordance with these pre-agreed terms.

Example: A, B, and C agree to dissolve their firm. The firm is dissolved by agreement.

Example: A partnership deed states that the firm will dissolve on 31st December 2025. The firm automatically dissolves on that date as per the contract.

Compulsory dissolution (Section 41)

Section 41: Compulsory dissolution

"A firm is dissolved—

(a) by the adjudication of all the partners or of all the partners but one as insolvent, or

(b) by the happening of any event which makes it unlawful for the business of the firm to be carried on or for the partners to carry it on in partnership."

Explanation:

Insolvency: If all partners become insolvent, or if all but one partner become insolvent, the firm is compulsorily dissolved. If only one partner remains and he is not insolvent, the firm may continue as a sole proprietorship if he chooses, but the partnership is dissolved.
Illegality of Business: If the business of the firm becomes unlawful (e.g., due to a change in law banning the trade they are engaged in), the firm is compulsorily dissolved.
Illegality of Partners Carrying on Business: If it becomes unlawful for the partners *as a partnership* to carry on the business (e.g., if a new law requires a specific license to carry on the business, and the firm as constituted cannot obtain that license), the firm is compulsorily dissolved.

Example: A and B are partners in a firm trading in certain goods. A law is passed banning the trade of those goods. The firm is compulsorily dissolved.

Dissolution on happening of certain contingencies (Section 42)

Section 42: Dissolution on the happening of certain contingencies

"Subject to contract between the partners a firm is dissolved—

(a) if constituted for a fixed term, by the expiry of that term;

(b) if constituted to carry out one or more adventures or undertakings, by the completion thereof;

(c) by the death of any partner; and

(d) by the adjudication of a partner as an insolvent."

Explanation: These events cause dissolution unless the partnership agreement specifies otherwise (e.g., agreement that death of a partner will not dissolve the firm, and the surviving partners may continue).

Expiry of Fixed Term: If the partnership was formed for a specified period, it dissolves when that period ends.
Completion of Undertaking: If the partnership was formed for a specific project or venture, it dissolves upon the completion of that project.
Death of any Partner: The death of any partner (unless agreed otherwise) dissolves the firm.
Insolvency of a Partner: The declaration of a partner as insolvent (unless agreed otherwise) dissolves the firm. (Note: If all partners are insolvent, it's compulsory dissolution).

Dissolution by notice (Section 43)

Section 43: Dissolution by notice of partnership at will

"(1) Where the partnership is at will, the firm may be dissolved by any partner giving notice in writing to all the other partners of his intention to dissolve the firm.

(2) The firm is dissolved as from the date mentioned in the notice as the date of dissolution or, if no date is so mentioned, as from the date of the communication of the notice."

Explanation:

Partnership at Will: This mode applies only to 'partnership at will' (Section 7), which is a partnership where no provision is made by contract for the duration of their partnership or for the determination of their partnership.
Notice in Writing: Any partner can dissolve a partnership at will by giving a written notice of dissolution to all the other partners.
Effective Date: The dissolution is effective from the date specified in the notice, or from the date the notice is communicated if no date is specified.

Dissolution by the Court (Section 44)

Section 44: Dissolution by the Court

A partner can file a suit in court seeking the dissolution of the firm. The court has the discretion to order dissolution under certain grounds:

(a) Insanity of a partner: That a partner has become of unsound mind. (The suit must be filed by another partner or the next friend of the insane partner).
(b) Permanent incapacity: That a partner, other than the partner suing, has become in any way permanently incapable of performing his duties as partner.
(c) Misconduct: That a partner, other than the partner suing, is guilty of conduct which is likely to affect prejudicially the carrying on of the business, regard being had to the nature of the business.
(d) Persistent breach of agreement or conduct not reasonably practicable to carry on business: That a partner, other than the partner suing, wilfully or persistently commits breach of agreements relating to the management of the firm or the conduct of its business, or otherwise conducts himself in such a way that it is not reasonably practicable for the other partners to carry on the business in partnership with him.
(e) Transfer of interest or sale of share: That a partner, other than the partner suing, has transferred the whole of his interest in the firm to a third party, or has allowed his share to be charged under a decree.
(f) Perpetual losses: That the business of the firm cannot be carried on save at a loss.
(g) Any other just and equitable ground: That the Court is satisfied that it is just and equitable that the firm should be dissolved. This is a broad discretionary ground covering situations where it is no longer fair or equitable for the partnership to continue.

Example: Disputes and deadlock among partners making it impossible to run the business could be a ground for dissolution on a just and equitable basis by the court.

Example 1. Mr. A, Mr. B, and Mr. C are partners in a firm. Mr. A passes away. The partnership deed does not mention what happens if a partner dies. Is the firm dissolved?

Answer:

Yes, the firm is dissolved. According to Section 42(c), subject to contract between the partners, a firm is dissolved by the death of any partner. Since the partnership deed does not provide otherwise (it does not state that the firm will continue with the surviving partners), the default rule applies. Mr. A's death dissolves the firm.

Example 2. Ms. D, Ms. E, and Ms. F are partners in a firm. Their partnership deed is silent on the duration of the partnership. Ms. D decides she no longer wants to continue and sends a letter to Ms. E and Ms. F stating her intention to dissolve the firm with immediate effect. Can she do this?

Answer:

Yes, Ms. D can dissolve the firm. Since the partnership deed is silent on the duration, it is a 'partnership at will' (Section 7). In a partnership at will, any partner can dissolve the firm by giving notice in writing to all the other partners of her intention to dissolve the firm (Section 43(1)). The firm is dissolved as from the date of communication of the notice (if no date is mentioned in the notice). So, by sending the letter (notice in writing) to Ms. E and Ms. F, she dissolves the firm.

Consequences of Dissolution

When a firm is dissolved, the partnership relationship between all partners comes to an end. The dissolution triggers a process of winding up the firm's affairs, which involves realizing the assets, paying off the liabilities, and distributing any surplus among the partners. Sections 45 to 55 deal with the consequences and the mode of settlement of accounts upon dissolution.

Liability for acts done after dissolution (Section 45)

Section 45: Liability for acts done after dissolution

"(1) Notwithstanding the dissolution of a firm, the partners continue to be liable as such to third parties for any act done by any of them which would have been an act of the firm if done before dissolution, until public notice is given of the dissolution."

Explanation:

Partners can still bind the firm and each other by their acts towards third parties even after dissolution, if the third parties are unaware of the dissolution.
To avoid future liability, public notice of dissolution must be given. Public notice is given by notification in the Official Gazette and by circulation in at least one vernacular newspaper circulating in the district where the principal place of business of the firm is situated (Section 72).
The estate of a partner who dies or is adjudicated insolvent, or of a partner who retires but whose retirement notice was not known to the third party, is not liable for acts done after death, insolvency, or retirement, respectively (Section 45 Proviso).

Settlement of accounts (Section 48)

Section 48 lays down the rules for the settlement of accounts between the partners upon dissolution of the firm. The assets and liabilities are applied in a specific order:

Subject to agreement between the partners, the accounts shall be settled in the following manner:

(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 the sums, if any, contributed by the partners to make up deficiencies of capital, shall be applied in the following manner and order:—

(i) in paying the debts of the firm to third parties;

(ii) in paying to each partner rateably what is due to him from the firm for advances as distinguished from capital (loans by partners);

(iii) in paying to each partner rateably what is due to him on account of capital; and

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

Explanation: This hierarchy ensures that external creditors are paid first, then partners' loans, then partners' capital, and finally, any remaining surplus is distributed as profit. Partners share losses in their profit-sharing ratio, making good any capital deficiencies from their personal assets if necessary.

Return of property contributed by partners (Partially covered by Section 48(b)(iii))

Upon settlement of accounts, after paying external debts and partners' advances (loans), partners are entitled to the return of their contributed capital. This is covered under Section 48(b)(iii). The amount due to each partner on account of capital is paid back rateably from the remaining assets. If the assets are insufficient to return the full capital, the partners share the capital deficiency as a loss in their profit-sharing ratio, making good the deficiency from their personal assets if required (Section 48(a)).

Other Consequences of Dissolution:

Continuing Authority for Winding Up (Section 47): Notwithstanding the dissolution, the authority of each partner to bind the firm, and the mutual rights and obligations of the partners, continue 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. This allows partners to realize assets, pay debts, and finalize accounts after dissolution.
Right to have business wound up (Section 46): On the dissolution of a firm, every partner or his representative is entitled 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.
Goodwill (Section 55): The goodwill of the business is included in the firm's property upon dissolution. It may be sold separately or with the other property of the firm. Any partner may bid for the goodwill at the sale.

Example 1. Mr. A, Mr. B, and Mr. C are partners sharing profits equally. The firm is dissolved. Firm assets amount to Rs. 15 Lakhs. External debts amount to Rs. 8 Lakhs. Mr. A had given a loan of Rs. 2 Lakhs to the firm. Partners' capital contributions were: Mr. A - Rs. 3 Lakhs, Mr. B - Rs. 3 Lakhs, Mr. C - Rs. 3 Lakhs. How will the accounts be settled?

Answer:

Accounts will be settled according to Section 48:

1. Pay external debts: From assets (Rs. 15 Lakhs), pay external debts (Rs. 8 Lakhs). Remaining assets = Rs. $15 - 8 = 7$ Lakhs.

2. Pay partners' advances: From remaining assets (Rs. 7 Lakhs), pay Mr. A's loan (advance) (Rs. 2 Lakhs). Remaining assets = Rs. $7 - 2 = 5$ Lakhs.

3. Pay partners' capital: From remaining assets (Rs. 5 Lakhs), pay partners' capital contributions (Total capital = Rs. $3+3+3 = 9$ Lakhs). The assets are insufficient to return full capital. Capital deficiency = Rs. $9 - 5 = 4$ Lakhs.

4. Share losses (deficiency of capital): The capital deficiency of Rs. 4 Lakhs is a loss to be shared by the partners in their profit-sharing ratio (equally). Each partner's share of loss = Rs. $4$ Lakhs / $3$ = Rs. $1,33,333.33$ (approx).

Since there is no residue, nothing is divided as profit. Each partner must contribute to make up the capital deficiency. However, the remaining assets (Rs. 5 Lakhs) will be distributed rateably towards capital first. Each partner's capital account was Rs. 3 Lakhs. Total capital Rs. 9 Lakhs. They receive Rs. 5 Lakhs back. Each receives Rs. $5/9$ of their capital back. E.g. A gets $(5/9) \times 3 = 5/3$ Lakhs = Rs. 1,66,666.67. Total received by A, B, C = $3 \times (5/3) = 5$ Lakhs (the remaining assets).

Let's verify: After liquidation, A is owed Rs. 3L (capital) + Rs. 2L (loan). B is owed Rs. 3L (capital). C is owed Rs. 3L (capital). Total owed to partners = Rs. 11 Lakhs. Assets remaining = Rs. 5 Lakhs. Total loss to partners = Rs. $11 - 5 = 6$ Lakhs.

Wait, my calculation of deficiency was wrong. Total assets 15L. Debts 8L. Net assets 7L. Total capital 9L. Total loans 2L. Total owed to partners = Capital + Loans = 9L + 2L = 11L. Net assets available = 7L. So, total loss to partners = 11L (owed to partners) - 7L (assets available after external debts) = 4 Lakhs. This loss of 4 Lakhs is to be shared by partners equally as deficiency of capital. Each partner's share of loss = Rs. $4$ Lakhs / $3$ = Rs. $1,33,333.33$.

Each partner's final position = Capital - Share of Loss. A: $3,00,000 - 1,33,333.33 = 1,66,666.67$. B: $3,00,000 - 1,33,333.33 = 1,66,666.67$. C: $3,00,000 - 1,33,333.33 = 1,66,666.67$. The remaining assets (Rs. 5 Lakhs) plus the partners' contribution to cover the loss (Rs. 4 Lakhs total from their personal assets, if needed) will be used to settle capital and loans. This doesn't seem right. The rules in Section 48(a) and (b) must be applied sequentially.

Let's apply Section 48 again. Assets: Rs. 15 Lakhs. Liabilities: External = Rs. 8 Lakhs, Partner Loan (A) = Rs. 2 Lakhs, Partner Capital (A, B, C) = Rs. 9 Lakhs. Total Liabilities (including capital/loans owed to partners) = 8 + 2 + 9 = Rs. 19 Lakhs.

Step 1: Pay external debts. Assets left: Rs. $15 - 8 = 7$ Lakhs.

Step 2: Pay partners' advances (loans). Assets left: Rs. $7 - 2 = 5$ Lakhs.

Step 3: Pay partners' capital. Total capital = Rs. 9 Lakhs. Assets available = Rs. 5 Lakhs. This means there is a capital deficiency of Rs. 4 Lakhs (Rs. 9 Lakhs - Rs. 5 Lakhs). This deficiency is a 'loss' under Section 48(a) to be shared by partners in profit sharing ratio (equally).

Each partner's share of loss = Rs. $4$ Lakhs / $3$ = Rs. $1,33,333.33$.

Each partner's capital account balance before sharing loss: A = 3L, B = 3L, C = 3L. Each partner's capital account balance after sharing loss: A = $3,00,000 - 1,33,333.33 = 1,66,666.67$. B = $1,66,666.67$. C = $1,66,666.67$. Total amount owed to partners on capital = $3 \times 1,66,666.67 = 5,00,000.01$ which matches the remaining assets of Rs. 5 Lakhs. So, the remaining assets of Rs. 5 Lakhs are distributed among partners in proportion to their final positive capital balances. Since the balances are equal, A, B, and C each receive Rs. $5,00,000 / 3 = 1,66,666.67$ from the assets.

So, from the Rs. 15 Lakhs assets: 8 Lakhs go to external creditors, 2 Lakhs go to A for his loan, and the remaining 5 Lakhs are distributed as Rs. 1,66,666.67 each to A, B, and C for their capital.

Final cash received: A = Rs. $2,00,000$ (loan) + Rs. $1,66,666.67$ (capital) = Rs. $3,66,666.67$. B = Rs. $1,66,666.67$ (capital). C = Rs. $1,66,666.67$ (capital). Total cash distributed = $3,66,666.67 + 1,66,666.67 + 1,66,666.67 = 7,00,000.01$. This doesn't match the remaining 5 Lakhs. The final positive balances after covering losses are distributed from remaining assets. A's share of assets = (A's final capital / Total final capital) * Remaining Assets = (1,66,666.67 / 5,00,000.01) * 5,00,000 = 1,66,666.67. So A, B, and C each receive Rs. 1,66,666.67 towards their capital. A also receives his loan back first.

Final distribution: 1. External creditors: Rs. 8 Lakhs. 2. Partner A (Loan): Rs. 2 Lakhs. 3. Remaining Assets: Rs. $15 - 8 - 2 = 5$ Lakhs. 4. Partner Capital: This remaining Rs. 5 Lakhs is distributed among A, B, and C in proportion to their capital contributions, up to the extent of the remaining assets. Their contributions were equal (3L each). So, the 5 Lakhs is divided equally. A receives = Rs. $5,00,000 / 3 = 1,66,666.67$. B receives = Rs. $1,66,666.67$. C receives = Rs. $1,66,666.67$. Total distributed from remaining assets = Rs. 5 Lakhs.

So, A receives his 2 Lakh loan back plus 1,66,666.67 towards his capital. B and C receive 1,66,666.67 each towards their capital. Total distributed = $8,00,000 (external) + 2,00,000 (A loan) + 5,00,000 (capital) = 15,00,000$, matching total assets.

The settlement confirms that after paying external debts and partners' loans, the remaining assets are distributed towards partners' capital. If assets are insufficient to cover full capital, the deficiency is shared as a loss, and partners contribute if needed. In this case, the assets were sufficient to partially cover capital but not fully, and the partners are not required to contribute from personal assets because the remaining assets covered the pro-rata capital claims.