This article is written by Vihanka Narasimhan, a law student from Jindal Global Law School, O.P. Jindal University. This article makes an attempt to explain the concept of reconstitution of a partnership firm in a simple manner.

It has been published by Rachit Garg.

Introduction

A partnership firm is said to be formed when an arrangement is made between two or more people to manage business operations and share the profits and liabilities as redecided. There are various reasons which can lead to certain changes in the structure of a partnership firm. Such changes may arise due to admission of a new partner, retirement of an old partner or alteration of partnership deed between the existing partners. This is called reconstitution of a partnership firm. In this article we are going to discuss the need for reconstitution and the ways in which it can take place.

What is a partnership firm

In India, all the laws concerning Partnership firms fall under the ambit of Indian Partnership Act,1932. Section 4 of this Act provides the meaning of the term ‘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.” In simple terms, a partnership is basically the association of two or more persons who operate a business together with the aim of earning profits and sharing those profits amongst themselves. It is very important to note that in most cases the amount of profit which a partner receives is directly proportional to the amount of capital invested by him. There can be two types of partnership. They can be as follows: –

Partnership at will

Section 7 of the act discusses this concept. In a situation where there is an absence of a provision in the contract made between the partners in relation to the duration of the partnership or the determination of the partnership then it can be conceived as partnership at will. 

Particular partnership

Section 8 of the act discusses this concept. In a situation where there is a presence of a provision in the contract made between the two or more persons in relation to the duration of the partnership or the determination of the partnership then it can be conceived as a particular partnership. Some examples of a particular partnership can be construction of a road, laying of a railway line, etc. It is important to understand that this type of partnership comes to an end as soon as the duties in the contract have been fulfilled.

Features of partnership firm

The following are the essential elements of a partnership in accordance to the Indian Partnership Act,1932: –

Association of two or more persons

In order to form a partnership, there should be a minimum of two persons involved. The Indian Partnership Act, 1932 remains silent on the maximum number of partners however some clarity regarding this issue has been provided in Companies Act, 2013. Section 464 of this act states that the number of partners should fall with the prescribed limit and should not exceed more than 100. It means that the rules limit can be prescribed but should be less than 100. It is also important to note that the current prescribed limit is 50. In case a partnership firm exceeds the prescribed limit, it will be deemed as an illegal association of persons.

Contract of partnership

In order to form a partnership, it is mandatory that two or more persons come into a contract. The contract of partnership can be express or implied in nature. Section 5 of the Indian Partnership Act states that the relationship between the partners of a firm arises from contract and not from status.

Profit-driven venture

In order to form a partnership, it is essential that it is formed in view of earning profits by the means of carrying out some business. The term business has been defined in Section 2(b) of Partnership Act as “every trade, occupation or profession.” This implies that a business venture created for charitable, religious and social purposes by two or more persons will not be considered as a partnership.

Sharing of profit

In order to form a partnership, the association of persons are required to divide profit amongst themselves. The profit can be divided on the basis of the amount of capital contributed or in case the contract between the partners is silent on the matter, it is divided equally.

Mutual agency

Mutual agency can be defined as a type of partnership agreement in which one partner’s actions in relation to the business can bind all partners. In simple language, each partner is the agent of the firm as well as of the other partners thus, making partners as both an agent and a principal to each other. The origins of this law can be traced back to the general law of agency.

Procedure for registering a partnership firm

The registration of a partnership is not compulsory by law and it is at the sole discretion of partners of the firm to register or not. It is, however, advisable to register a firm as it provides for legal protection in case a dispute arises between the partners. The following are the steps to register a partnership firm :-

Step 1: Application for registration

An application form (Form A) has to be filed to the Registrar of Firms of the State in which the firm is operating. The registration application has to be signed and verified by all the partners or their agents. The application is necessary to file as a partnership firm is required to disclose basic details which are as follows –

  • Name of the Partnership Firm
  • Name and address of all partners
  • Place of business (address of main and branch offices)
  • Duration of the partnership
  • Date of joining of partners
  • Date of commencement of business

Step 2: Filing partnership deed

A partnership deed can be defined as an agreement between the partners which specifies the details with regards to each partner’s rights, duties, profits shares and other obligations. After filing an application, a copy of the partnership deed should be filed with the registrar of firms.

Step 3: Payment of fee and stamp duties

The next step is the payment of fees and stamp duties. It is crucial to note that stamp duties vary from state to state.

Step 4: Certificate of incorporation

After following all the above steps and the approval of the same from the registrar, a certification of incorporation is issued. This process will ensure that the firm has been entered into the records and consequently gains legal recognition. The whole process generally takes 12-14 days.    

Reconstitution of a partnership firm

Any changes in the constitution of the firm or change in relation of partners or restructuring of the partnership firm can be defined as ‘reconstitution of a partnership firm’. Reconstitution leads to changes in the firm which put an end to the pre-existing agreement between the partners and results in the formation of a new agreement in its place. Under the Indian Partnership Act, 1932, Sections 31 to section 35 broadly deal with the Reconstitution of a partnership firm.

Example

A, B and C are partners of a firm sharing profits in the ratio of 2:2:1. Their capital contributions are Rs.10000, Rs.10000 and Rs.5000 respectively. One day all the partners decide that C should bring in an additional capital of Rs.5000. This makes the new capital as Rs.10000 each which results in a change in the profit-sharing ratios to 1:1:1. The arrangement can be called a reconstitution of a firm as a change in the structure can be observed. 

Need for reconstitution in a partnership firm

Reconstitution of a partnership firm takes place whenever there is a change in the profit-sharing ratio among the partners, admission of a new partner, retirement of a partner and death or insolvency of a partner. This process of reconstitution can lead to the following changes in an organisation: –

  • Determination of sacrificing ratio and gaining ratio between continuing partners
  • Accounting for goodwill
  • Accounting treatment of reserves and accumulated profits
  • Accounting for revaluation of assets and liabilities
  • Adjustment of capitals

Modes of reconstitution of a partnership firm

Change in profit sharing ratio among partners

A firm is said to have reconstituted when there is a change in the amount of profit shared between the partners. This can be done with the mutual consent of all the partners and will result in the formation of a new partnership deed.

Admission of a new partner

A firm is said to have reconstituted when the admission of a new partner takes place. Section 31 of the Indian Partnership Act discusses the same in detail. The act states that the following are essential for the admission of a new partner in the firm –

  • Consent of the existing partners for admission
  • The admission should be in conformity with the agreement between the partners and the provision of partnership deed

The newly admitted partner is also known as ‘incoming partner’. It is important to note that all the transactions made prior to the admission of the new partner will not be binding on him unless an agreement is made regarding the same.

Retirement of a partner

A firm is said to have reconstituted when the retirement of the partner takes place. Section 32 of the Indian Partnership Act discusses the same in detail. The act states that the following are essential for the retirement of an existing partner in the firm –

  • Consent of the existing partners for retirement
  • The retirement should be in conformity with the agreement between the partners and the provision of partnership deed

In case, it is partnership at will, a notice in writing by the partner retiring to all the other partners would suffice. The retiring partner is also called ‘outgoing partner.’ The liability of the retiring partner for does not cease till the day he retires however it is discharged in case –

  • The partners of the reconstituted firm decide to take over his liability
  • The third party decides to set free the retiring partner and accepts the partners of the new firm as the debtors.

Removal of a partner

A firm is said to have reconstituted when an existing partner is expelled. Section 33 of the Indian Partnership Act discusses the same in detail. The act states that that the following are essential for the of the expulsion an existing partner in the firm –

  • Partnership deed provides for the power to expel the partner
  • Should be exercised by majority of the partners
  • Should be done in good faith

After being expelled from the firm, there is no liability of the expelled partner for the acts or debts of the firm. The partner is deemed liable only for the transactions made in the tenure of his partnership. This, however, is discharged when: 

  • The partners of the reconstituted firm decide to take over his liability
  • The third party decides to set free the retiring partner and accepts the partners of the new firm as the debtors.

Insolvency of a partner

A firm is said to have reconstituted when the insolvency of a partner takes place. Section 34 of the Indian Partnership Act discusses the same in detail. The act states that the following is provided when an existing partner is declared insolvent –

  • The insolvent partner ceases to be partner of the firm from the date of being insolvent
  • Dissolution of the firm takes place when no provision is stated in contract.

Death of a partner

A firm is said to have been reconstituted when the death of a partner takes place. Section 42 of the Indian Partnership Act discusses the same in detail. The estate of the deceased partner is liable for his acts done or liabilities incurred before his death. It is however discharged if the firm agrees to continue the business.

Impact of reconstitution on a partnership firm

There are many changes when the structure of a partnership firm is altered. The impact of reconstitution of firm are as follows –

Change in mutual right and duties

Section 17(c) of the Partnership Act, 1932 states that “where a firm constituted to carry out one or more adventures or undertakings carries out other adventures or undertakings, the mutual rights and duties of the partners in respect of the other adventures or undertakings are the same as those in respect of the original adventures or undertakings.” In simple language, it means that on reconstitution of the firm, the rights and duties of the partners remain the same as they were before the reconstitution. 

Revocation of continuing guarantee

Section 38 of the Partnership Act, 1932 states that “A continuing guarantee given to a firm, or to a third party in respect of the transactions of a firm, is, in the absence of agreement to the contrary, revoked as to future transactions from the date of any change in the constitution of the firm.” In simple language, it means that on reconstitution of the firm the continuing guarantee given on behalf of the firm or to the firm stands revoked as to future transactions from the date of reconstitution.

Conclusion

A partnership is an arrangement that has taken place between two or more persons to manage a business with the aim of sharing its profits and liabilities. In totality, this arrangement is a consequence of meeting a mutually beneficial objective amongst all the partners. Any changes, big or small will result in some alteration in the relationship between the partners of a firm ultimately resulting in the reconstitution of the firm itself. In conclusion, the concept of reconstitution is vital for the development of the growth of the business. 

References

  1. https://www.mca.gov.in/Ministry/actsbills/pdf/Partnership_Act_1932.pdf
  2. https://www.investopedia.com/terms/p/partnership.asp
  3. Introduction to Law of Partnership Including Limited Liability Partnership by Avtar Singh

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