This article is written by Ilashri Gaur, a law student pursuing B.A. LLB (Hons.) from Teerthanker Mahaveer University (CLLS). This article contains all the information regarding the dissolution of the firm.

Introduction

Before we discuss the consequences of dissolution of a partnership firm, let’s first understand the meaning of the dissolution of the firm.t means when the partnership between all the partners dissolved, then it is called dissolution of the partnership firm. After the dissolution of the firm, the partners have certain rights and liabilities as per the Indian Partnership Act, 1932, which provides the consequences of the dissolution of the firm. In a partnership firm, there are more than two partners. This process includes the disposing of all the assets and settlement of all the accounts and liabilities of all the partners. 

Section 4 of the Indian Partnership Act,1932 defines partnership. As it is the relation between the partners who entered into a business and share all the profit and losses. Under the partnership deed, all the profit and losses are shared accordingly. Partnership deed is an agreement between the partners in which all the terms and conditions are outlined.

Advantages and Disadvantages of partnership firm

There are always advantages and disadvantages of everything. The partnership firm has also certain advantages and disadvantages, which are:

Advantages

1. Partnership firms are easy to start in most of the cases as there is only a requirement of partnership deed.
2. Decision making is one of the most difficult problems in any organization but in the partnership firm one can make decisions easily and the partners can enjoy a wide range of powers.
3. As compared to other firms, a partnership firm can easily raise funds. As by the contribution of the multiple partners raising funds to become more convenient.
4. There are fewer chances of risk in partnership firms as risk is shared by all the partners in the firm.

Disadvantages

1. There is unlimited liability. As a partner is liable personally for all the losses of the partnership firm.
2.  It is necessary that all the partners have to work with unity if one partner has some trust issues other than it can lead to a difficult situation for the partnership firm.
3. The maximum number of partners can only be 20. In the case of limited liability partnership (LLP), there is no restriction regarding the number of members.
4. A partnership can be dissolved due to the death of a partner or insolvency of the partner.

Dissolution of firms

Section 39 of the Indian Partnership Act, 1932 defines the dissolution of partnership firms. The dissolution of the firm means to stop all the business activities with the firm. There is a difference between the dissolution of the firm and the dissolution of the partnership. 

When all the activities regarding business stops and all the profit and loss is settled among the partners is called dissolution of the firm and when the partner takes the retirement from the firm even though the firm continues to perform its activity with another partner is called dissolution of a partnership.

The Indian Partnership Act, 1932 defines dissolution in different ways:

Ways of dissolution

Section 40 defines dissolution by agreement.

Section 41 defines compulsory dissolution.

Section 42 defines dissolution on the happening of certain events.

Section 43 defines dissolution by notice of partnership at will.

Section 44 defines dissolution by court.

Let us understand these sections in-depth:

Section 40- Dissolution by agreement: it means a firm can be dissolved with the agreement in which the consent of all the partners are mentioned and by the mutual consents of all the partners to dissolve the firm. Without the interruption of the court, one can dissolve it simply.

Section 41- Compulsory dissolution: compulsory dissolution can be because of many reasons.

• If all the partners become insolvent or if all the partners except one become insolvent then the firm will be dissolved.
• If partners are carrying out a business of unlawful activities like drugs, selling illegal products, etc then it will be dissolved.

Section 42- Dissolution on the happening of a certain event: under these events a firm can dissolve.

• If the partnership is done for a particular period of time and when that period expires then the firm dissolves.
• Dissolution can also take place due to the death of the partner but if other partners want to continue they can.
• If the partners of the firm are insolvent or one partner then the dissolution takes place.
• If the partnership is created for a specific adventure or undertaking and if that objective is done then the firm will dissolve.

Section 43- Dissolution by notice of partnership at will: the firm can be dissolved by any partner by giving notice in writing to all the other partners and that notice must be well communicated to all the partners by which the firm can dissolve.

Section 44- Dissolution by court- the dissolution can be done in a formal manner by suing the other partners and the grounds on which court can dissolve the firm are:

• When one of the partners becomes unsound in that case the other partners can file a suit and bring the case to the court to dissolve the firm.
• When the partner is unable to perform his duties permanently due to which the other partners file a case and dissolve the firm. The reason for the incapability of work can be imprisonment for a longer time.
• If the partner commits such an act that brings guilt and affects the reputation of the firm due to which firm faced losses then in that case court may order to dissolve the firm.
• If the partner breaches the agreement of the firm then the court may order for the dissolution of the firm. As it is the most important document of any firm.
• If the partner transfers his full interest to the third party and allowed his share to be charged under the provision of rule 49 of Order XXI of the First Schedule to the Code of Civil Procedure, 1908 (5 of 1908) and allow it to be sold in the recovery area of land revenue because of the partner than the court can order for dissolution of the firm.
• If the firm is facing a continuous loss, then the court can order for the dissolution of the firm.

Judgements regarding dissolution of firm

Prakash Chand vs Bhanwar Lal & Anr (2009)

In this case, the petitioner has submitted the application under section11 of the Arbitration act. A partnership deed was duly executed on 13.8.1975 and the partnership is a registered partnership firm under the provisions of Partnership Act. A lease deed was executed and as per the petitioner, in favour of both the partners constituting partnership firm M/s B.P. Textiles. 

According to the petitioner, this lease deed is subsisting till today. According to the petitioner himself, he separated from the business of the firm on 16.4.1978, however, the accounts books, as well as properties, remained in possession of respondent-Bhanwar Lal. So, in this case, the court held that there is no live dispute between the parties which can be referred to the Arbitrator and in the result the petition filed by the petitioner is dismissed.

Mohinder Nath & Ors. vs Sh. Narender Nath & Ors. (1998)

In this case, the appellant and respondent (1) are the real brothers and were partners in a partnership firm. Each one of the said parties had a 15% share in the firm and the remaining 40% was held by their mother. The plaintiff/respondent no.1 filed the suit for dissolution of the firm and for rendition of accounts. 

The mother of the parties holding 40% share was not made a party in the suit and on objection having been taken by the respondent that the suit was not maintainable, the plaintiff made an application before the Judge for impeding the mother as one of the defendants. The judge said that the partnership was at will and the same stood dissolved from the date of service of notice of the suit on the defendants. 

The Court also held that the entitlement of the plaintiff to the 15% share in the firm was not disputed and the Court was, therefore, satisfied that the plaintiff was entitled to the appointment of the receiver and consequently an Advocate was appointed the receiver to take charge of the business and all the assets of the firm and at last court said that the parties will bear their own costs.

Consequences of dissolution of partnership firm

Rights after dissolution

Section 46 of the Indian Partnership Act, 1932 provides the rights of partners to have business wound up after the dissolution of the firm. It says that after the dissolution of the firm, all the partners or his representative are entitled to the property of the firm as applied in the payment of debts and liabilities of the firm and the surplus to be distributed among all the partners of the firm.

Liabilities after dissolution

Section 45 of the Indian Partnership Act, 1932 provides liabilities for an act of the partners after the dissolution of the firm. According to this section, the partners of the firm are liable to the third party for any act done by any of them unless they give public notice of the dissolution of the firm. 

It also states that the partner who dies, retries, becomes insolvent or that of a person who the third party is not aware of being the partner of the firm, is not liable under this section.

In simple words, it protects the third party who doesn’t know about the dissolution of the firm.

There is a difference between the firm’s debt and private debt.

Basis	Firm’s debt	Private debt
Meaning	It means the debt owed by the firm by outsiders.	It means the debt owed by a partner in his personal capacity to another person.
Liability	All the partners are jointly liable and severally for the firm’s debt.	The concerned partner is particularly liable for his private debt.
Application of the firm’s property	Firm’s property is applied first to settling the firm’s debt.	Share of the partner in excess of the firm’s property over a firm’s debts can be applied for private debts.
Application of private property	The excess of the partner’s private property over his debts can be applied for the firm’s debt.	Private property is first applied for private debts.

Settlement of accounts after the dissolution of the firm

Section 48 of the Indian Partnership Act defines the ways of settling the accounts of the firm. The firm will pay all the losses including the deficiency of the capital out of the profit and then from the partner’s capital and by the partners individually in their profit sharing ratio.

The firm applies its assets including any contribution to make up the deficiency for paying to the third party and then for paying any loan or advances by the partner and lastly for paying back their capitals and if any surplus left after all this then it will be divided between the partners in their profit sharing ratio.

Return of premium after dissolution

Section 51 of the Indian Partnership Act defines the return of premium after dissolution. At the time of entering into a partnership firm, the partner has to pay an amount as premium. So when the firm dissolves before the time period due to any reason, then he is entitled to the repayment of premium. 

The term upon which he becomes a partner and to the length of the time during which he was a partner such part will be repaid unless the dissolution is mainly due to his own misconduct or the dissolution is in pursuance of an agreement containing no provision for the return of the premium or any part. 

Agreements in restraint of trade 

Section 54 of the Indian Partnership Act defines the agreement in restraint of trade. Let us understand the meaning first, it means that when one party agrees with the other party to restrict his liberty to carry on the specific trade even in the present or in the future. This section defines that partners in anticipation of the dissolution of the firm make an agreement that some or all the partners will not carry any business similar to that of the firm even for a specific period or within specific local limits.

Sale of goodwill after dissolution

Section 55 of the Indian Partnership Act deals with the sale of goodwill after dissolution. There are certain ways for sale of goodwill: 

1. When the accounts of the firm are settled after the dissolution, the goodwill shall be subject to the contract between the partners be included in the assets or it will be sold separately or along with the other property of the firm.
2. Rights of the buyers and sellers of goodwill:

• When the goodwill of the firm is sold after the dissolution, a partner may be competing with that of the buyer but the subject to the agreement between them, he may not use the firm’s name, he may not present himself on carrying on the business firm or he may not ask the customs of persons carrying the firm before dissolution.
• Any partner upon the sale of goodwill makes an agreement with the buyer that such partners may not carry on such business similar to that of the firm within a specified period or within a specified local time.

Conclusion

The conclusion of this article is that the Indian Partnership Act, 1932 provides provisions regarding the dissolution of the firm. This act helps the people who want to dissolve the firm so that no one can take the wrong advantage for the same. 

With the dissolution of the firm, you have certain consequences regarding the same as you have to close the books of account, all the liabilities must be settled by the partners and the profit and losses will be shared by the partners as per the terms of the agreement. 

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