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Advantages and disadvantages of a partnership

May 26, 2022

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This article has been written by Adhila Muhammed Arif, a student of Government Law College, Thiruvananthapuram. This article seeks to explain what a partnership firm is, how it is different from other associations such as registered companies, and overall advantages and disadvantages of a partnership.

It has been published by Rachit Garg.

Introduction

In the words of Sir Frederick Pollock, “partnership is the relation that subsists between persons who have agreed to share the profits of a business carried on by all, or any of them, or on behalf of all of them”. A partnership firm refers to an organisation of two or more persons where they are co-owners of a business, and agree to share the profit as well as the losses derived from it. The term ‘partnership’ is used to denote the relationship between those persons. There are different forms of associations such as that can function in this manner and partnership happens to be one among them. The right to form a partnership is a part of the right to form an association, which is a constitutional right as per Article 19(1)(c) of the Indian Constitution.

Partnership: meaning and nature

What is a partnership (Section 4, Indian Partnership Act)

The law that governs partnership is the Indian Partnership Act, 1932. According to Section 4 of the Partnership Act, partnerships refers to the relationship between persons who have agreed to share the profits of a business carried on by all of them or any of them acting for all of them. A partnership firm cannot be viewed as an entity that exists on its own distinct from its members. It is only for the purpose of taxation that it is considered as a distinct personality.

Essentials of a partnership

In the case of Deputy Commissioner of Sales Tax (Law), Board of Revenue (Taxes), Ernakulam v. K. Kelukutty (1985), the Supreme Court laid down the definition of partnership as “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”. The Supreme Court elucidated Section 4 of the Act and stated that individually, the members are partners, and collectively they are a firm. According to the court, the components of a firm are

(a) persons

(b) a business carried on by all of them or any of them acting for all, and

To explain further, the following are the essential requisites of a partnership:

An association consisting of two or more persons

It is not possible for one person to become a partner on his own. A minimum number of two persons must be there to form a partnership. As per Section 42, in cases where the number of partners gets reduced to one due to reasons such as death and insolvency, the partnership stops existing immediately, even when the contract of the partnership states otherwise. This Act does not lay down the maximum number of persons that can be a part of a partnership firm. However, Rule 10 of the Companies (Miscellaneous) Rules, 2014 states that only a maximum of fifty people can form a partnership to carry on a business.

Origin from an agreement

The partnership must arise from a valid agreement. The agreement can be expressed or implied by the parties’ conduct. It must fulfil all the requirements of a contract. Section 11 of the Act clarifies that for entering into a partnership, the person must be of the age of majority, of sound mind, and not disqualified by any other law in force at that time. Section 5 of the Act makes it clear that a partnership does not arise from status but from a contract.

Combining of labour, skill and property

In most firms, all the partners make some kind of contribution with their skills, labour or even property. However, in many firms, some members do not contribute anything. Such members can be called partners if they undertake liability as partners.

Business or commercial activity

Section 2(b) of the Partnership Act defines business as any trade, occupation, or profession.

Carried on by all or any of them on behalf of all

In a firm, the partners are agents and principals of each other. For the actions of each partner, all the other partners are liable.

Sharing of profits

One of the essential conditions of the existence of a partnership is the object of sharing profits of the business of an association.

Difference between a partnership and a co-ownership

Co-ownership is essentially a form of association that we can find among joint-purchasers, co-heirs and even co-tenants. They are a group of people who have ownership of an asset and earn some kind of benefit or revenue in either the same or different proportions.

In the case of Rashmi Naqrath v. Sarva Priya Cooperative House (1997), it was held that co-ownership in itself is not a partnership even if they earn some profit from a common thing. It is necessary for all the parties involved to consent to trade as partners for there to be a partnership.

In the case of Central Engineering Works vs Competent Authority (1988), the following points were cited as the difference between co-ownership and partnership:

1. Co-ownership is not necessarily the result of an agreement, whereas a partnership is.

2. Co-ownership does not necessarily involve sharing of profit or loss, but a partnership does.

3. One co-owner can, without the consent of the other, transfer his interest, etc., to a stranger. A partner cannot do this.

4. In a partnership, each partner acts as an agent for the others. In a co-ownership, one co-owner is not, as such, the agent, real or implied, of the other.

To sum up, the following are the differences between a partnership and a co-ownership:

Sl.No.	Partnership	Co-ownership
	A partner is not entitled to transfer his interest to a third party as a substitute partner without the consent of the other partners.	A co-owner can transfer his interest to a third person without the consent of other co-owners
	Partners are agents for each other	There is no mutual agency in co-ownership
	A partner being an agent has the right to lien over the partnership property, as per Section 221 of the Indian Contract Act, 1872.	There is no such right in a co-ownership. A co-owner can only be entitled to partition, and for the sale of such property, he would require the consent of the other co-owners.
	When a partner causes any losses due to fraud, he is required to indemnify the firm.	Noone can be held liable for losses due to fraud in a co-owenrship

Advantages of a partnership firm

The following are the advantages of forming a partnership firm over other associations or other models of business:

Easy to form

It is easier to create a partnership firm than an association like a company. It does not require registration. It can be formed simply by an agreement between two or more parties. Even dissolving a firm can be done instantly due to any of the reasons prescribed by the Partnership Act.

Utilisation of skills

In a partnership firm, all the partners are involved in managing the firm. This utilises the variety of skills possessed by all the partners in performing the tasks related to the management of the firm.

Pooling of capital and resources

As a partnership firm has many persons involved, it also brings the firm more resources and capital to conduct business.

Sharing of risk

As there are multiple persons involved in a partnership business, it is easier to bear the risks or losses incurred from it.

No filing of annual returns

For associations like companies, it is required to submit an annual return to the Ministry of Corporate Affairs. It is essentially a document that contains details of a company’s share capital, indebtedness, directors, shareholders, changes in dictatorships, corporate governance disclosures, etc. However, a partnership firm does not require any such things.

Flexibility

The nature of a partnership firm is very flexible as there is only a few legal formalities. It is easier to make decisions in a partnership firm in comparison with other entities.

Auditing

All partnership firms do not require to get their accounts published and audited. As per the Income Tax Act, 1961, a tax audit of a partnership firm is mandatory only if the turnover of the firm exceeds one crore Rupees. However, in the case of a company, tax auditing is compulsory regardless of its turnover.

Disadvantages of a partnership firm

The following are the disadvantages of having a partnership firm over other forms of business:

Consequences of not registering a firm

Though it is not compulsory to get a firm registered, it has its consequences as laid down in Section 69 of the Partnership Act. the following are the disadvantages of not getting a partnership firm registered:

Not being able to sue a partner or the firm itself in order to enforce a contractual or statutory right;
Not being able to sue a third party for enforcing a contractual right, and
Not being able to claim set off.

Transferability of share or interest

A partner cannot transfer his interest in the firm’s business to a third party without the consent of the other partners. It makes a share or investment in a firm’s business an illiquid asset.

Uncertainty

Conducting a business through a partnership firm makes it very unstable and uncertain. This is because of the fact that a partnership gets dissolved immediately due to the death, insolvency, or retirement of any of the partners.

No public scrutiny

Since it is not compulsory for all partnership firms to be subjected to auditing, there is no public scrutiny regarding the revenue a firm generates. This leaves the public suspicious about the firm’s creditworthiness.

Lack of leadership

Since all partners in a firm are on an equal footing and have the same roles, there is a lack of leadership in managing the firm’s business.

No perpetual existence

As a partnership firm does not have a legal personality of its own, it comes to an end when one of the partners dies, resigns, or becomes insolvent, unless it is otherwise agreed by the partnership contract. The existence of the firm is solely dependent on the partners that constitute it.

Limit on the number of partners

There is a statutory limit on the number of partners that can form a firm which is fifty. However, to form a private company the maximum number of shareholders is two-hundred.

Conclusion

To conclude, forming a partnership firm to conduct business has many advantages as well as disadvantages. The regulations that govern partnership firms are lesser than the ones that govern companies. This makes creating and running a partnership firm far easier than running a company. However, due to a partnership firm not having a distinct personality, business conducted by a partnership firm is a more uncertain place in comparison with a business run by a company.

References

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Advantages and disadvantages of a partnership

Introduction

Partnership: meaning and nature

What is a partnership (Section 4, Indian Partnership Act)

Essentials of a partnership