This article has been written by Meera Patel, a B.A. L.L.B student from the Maharaja Sayajirao University, Faculty of Law, Vadodara. This article defines and differentiates the meaning of dissolution of a firm and a partnership.
This article has been published by Sneha Mahawar.
The most basic distinction between the dissolution of a partnership and the dissolution of a firm is that the former is the dissolution of an operation of a business and the latter one is the dissolution of a business relationship among the partners. What this statement means is that the dissolution of a partnership is not the same as the dissolution of a firm. This is because when the legally justifiable relation present among the partners ceases, it is known as the dissolution of a firm whereas when a partner becomes unfit for the firm the partnership of that particular partner comes to an end with the firm but that does not mean the firm ceases to operate. The firm may function very well on its own as per the desire of other partners.
One of the radical differences between the dissolution of a firm and the dissolution of a partnership is that in a situation where a partnership dissolves, no other dissolution takes place but when a firm is dissolved, all the partnerships come to an end as well.
As per Section 39 of the Indian Partnership Act, 1932, the dissolution of a partnership refers to the process of terminating the professional relationship between the partners involved in the business due to various circumstances. This termination also puts an end to and divides all the assets, liabilities, debts, accounts, and shares related to the partnership among the partners in the form of a settlement deed. The main thing that highlights this Section is that even though the process of dissolving a firm and dissolving a partnership looks similar, they are completely different. Read this article to know the difference between a partnership and a firm and how dissolution differs in both.
Definition of a partnership
As per Section 4 of the Indian Partnership Act, 1932, “a partnership is the relation between persons who have agreed to share the profits of a business on by all or any of them acting for all”. Listed below are all the essential elements required to form a partnership as per the Indian Partnership Act, 1932:
- The existence of an agreement between partners is necessary.
- The main motive behind forming a partnership is to earn profit and split it among the partners.
- As per the agreement, it is necessary to abide by the fact that the agreement must be to carry out the business jointly or in situations where that is not possible, other partners must act on behalf of all.
Illustration: Ashish and Anish buy 200 bags together after they enter an agreement where they will sell customized bags for their joint account. This is a perfect example of forming a partnership and here, Ashish and Anish are considered partners.
In a different situation, Ashish and Anish buy 200 bags and they agree to share them among themselves. This situation will not be counted as a partnership as they have no intention to carry out a business
In the case of N. Gurava Reddy v. the District Registrar (1976), the applicants and 6 other people along with their legal heirs of P. Sri Devamma were partners in a business. The legal representatives along with the five other partners wanted to retire from the partnership therefore they decided to dissolve the partnership. The dissolution was executed on stamp papers and the decision was made in the favor of the partners who wanted to dissolve the partnership.
Dissolution of a partnership
The abstract relationship that is legally binding between 2 or more partners is known as a partnership. That is the reason why dissolving a partnership is like terminating the legal relationship between partners.
There are various reasons why partners might want to dissolve a partnership such as a retirement, incapacity of a partner due to death, insanity, or any other cause that might cause the incapacitating role in the partnership and that is how a partnership might come to an end voluntarily or involuntarily.
Even if one or more partners decide to dissolve a partnership, the remaining partners have it under their discretion if they want to continue the firm, so that the firm does not lose its existence. The only difference is that when the remaining partners decide to not continue the firm and undertake the business further, the firm is dissolved automatically. Another important thing to keep in mind is that when a partnership is dissolved, the old agreement is automatically terminated and a new agreement is used as a replacement.
Listed below is a list of ways a partnership can be dissolved:
- Admitting another partner as a replacement
- Insolvency of a partner
- Revising the profit share ratio
- Expiration of the partnership term
- After completing the goal/ venture decided while forming a partnership
- Death of a partner
- Retirement of a partner
- Dissolving the partnership via an agreement
Modes of dissolving a partnership
By operation of law
Being the consequence of an agreement, the partnership is governed by the law. This reason alone should justify that if any unlawful activity takes place, the partnership shall be deemed dissolved.
Illustration: A and B decide to form a partnership and sell liquor in Gujarat which is a dry state. This partnership is valid but the object is illegal therefore this partnership shall be considered dissolved by the law.
By the decree of a court
Using this mode of dissolving a partnership, a partner can dissolve a partnership by approaching the court. The court can allow the dissolution of a partnership under certain circumstances. These conditions are:
- If the partner is not capable of working.
- Insanity and mental instability
- Breach in an agreement
- Bad behavior of a partnership results in bad image issues for the firm or other partners
Illustration: A, B, C, and D were partners in a firm. Due to a freak accident, B was handicapped and was unable to carry out his duties therefore all the other partners approached the court so that they could get the necessary help which will help them end their partnership with B.
Statement of dissolution
This is the simplest mode used to dissolve a partnership. The concerning party needs to fill out a statement form addressing the secretary of the State. The name of the partnership, date of filling the form, and a reason for dissolution are the most important things to be filled in the said form.
Act of partners
Using this model, when the partners want to dissolve a partnership, the remaining partner/ partners shall agree and decide a suitable time for the partnership to end. Partners have the liberty to come to an agreement for things like the time period but the remaining partner who wants to end the partnership also has the right to dissolve a partnership before the time period ends but only under certain circumstances.
Illustration: A, B, C, D, and E are in a partnership. A decides to end his partnership and after discussing his decision with his partners, they decide that he will work for another 3 weeks till they find a replacement for him. Due to a heart attack, he was asked to rest for some time, thus, he was on bed rest before the completion of his three weeks.
Definition of a firm
Section 4 of the Indian Partnership Act, 1932 also clarifies the meaning of a partnership firm. As per the aforementioned section, “persons who have entered into a partnership with one another are called individual partners and collectively they are known as a firm”.
As mentioned above, the dissolution of a firm is different from the dissolution of a partnership. Discontinuing all the business-related activities such as generating profit and loss within the firm is known as the dissolution of a firm. When these activities are stopped, the assets are usually used to pay off the debts if there are any. Dissolution of a partnership does not amount to the dissolution of the firm but a dissolution of a firm does amount to the dissolution of a partnership.
In the case of Malabar Fisheries and Co. v. Commissioner of Income Tax(1979), the effect as well as impact of assets and discharging the liabilities have been stated and explained by the honorable Supreme Court of India. The Court stated that, “ Dissolution of a firm must, in point of time, be anterior to the actual distribution, division or allotment of the assets that takes place after making accounts and discharging the debts and liabilities due by the firm. Upon dissolution the firm ceases to exist and then follows the making up of accounts, then the discharge of debts and liabilities and thereupon distribution, division or allotment of assets takes place between the erstwhile partners by way of mutual adjustment of rights between them. The distribution, division or allotment of assets to the erstwhile partners, is not done by the dissolved firm. It is not correct to say that the distribution of assets takes place eo instanti with the dissolution of the firm or that it is affected by the dissolved firm.”
Dissolution of a firm
As per the Indian Partnership Act, 1932, all the terms and conditions must be abided by any partner who wishes to end the partnership. Listed below are the provisions are given in this Act which states the different ways through which one can end a firm:
Section 40 : Dissolution by agreement
As per Section 40 of the Indian Partnership Act, 1932, any and all firms can be dissolved via an agreement. Legal consent from all the partners is equally necessary as is the legality of the agreement. All the partners can dissolve the firm without even involving the court in their process at all.
Section 41 : Compulsory dissolution
According to Section 41 of the Indian Partnership Act, 1932, all the partners are bound to compulsorily dissolve the firm. The compulsion factor might come in the scenario due to multiple reasons. The said reasons are:
- Insolvent partners
- Only one partner is not insolvent amongst all the other insolvent partners
- The partners are a part of illegal and unlawful activities which might include illegal objects.
Section 42 : Dissolution on the happening of contingencies
According to Section 42 of the Indian Partnership Act, 1932, a firm can be dissolved by the partners only under certain circumstances. These circumstances include:
- The partnership should be ended as per the pre-decided time and after the completion of a certain set goal/ venture.
- A firm can be dissolved if all the partners die. Although, if a partner dies, the other partners can continue to run the firm/ business if they wish to do so that shall be classified as dissolution of a partnership and not a firm.
- As stated above, if the partners are insolvent, then the firm can be dissolved.
Section 43: Dissolution of a firm via notice
As per Section 43 of the Indian Partnership Act, 1932, a firm can be dissolved by one of the partners via a notice. The partner that wishes to dissolve the firm must approach the firm with a request to issue a notice to all the other partners to communicate the intentions of dissolving the said firm.
Section 44 : Dissolution by court
As per Section 44 of the Indian Partnership Act, 1942, a partner can dissolve the firm by suing the other partners. Using this method, a partner can sue all the other partners when:
- A partner can dissolve a firm if other partners are unable to perform the promised duties. There are various reasons by which a partner shall be deemed incapable to perform the promised duties and medical reasons, imprisonment for the long term, insanity, etc shall also be considered here.
- In situations where a partner transfers the entire portion of their share/ interests to a third party or in simpler words if the partner decides to breed, the pre-decided agreement related to the firm can become the ground for the dissolution of the firm.
- In situations where the partner hinders the reputation of the firm by their actions which are treacherous in nature, this activity can become the ground for all the other partners to dissolve the firm.
- When one partner becomes of unsound mind or mentally unstable, that is when the other partners have the authority to sue the said partners so that the court can dissolve the firm.
Differences between dissolution of partnership and dissolution of a firm
|The process of ending a legal relationship between a partner and the rest of the partners in a company/ enterprise/ firm. |
When a partnership is dissolved, other partners of the firm may or may not continue the business.
Court intervention is not needed.
There is no closure needed in the books as the business does not cease if a partnership ends.
The dissolution of a partnership does not necessarily result in the dissolution of the firm.
|The process of dissolving all the partnerships of the company/ enterprise/ firm which results in dissolving the firm is known as dissolving a firm. |
When a firm is dissolved, all the business-related activities are stopped.
Courts can help the partners dissolve the firm.
The books need closure as the business ceases.
The dissolution of a firm also results in the dissolution of partnerships.
The Indian Partnership Act, 1932 clears it out for us that there is a huge difference between the dissolution of a partnership firm and the dissolution of a partnership. As per the explanation given above, we can say that when a partnership ends, it does not necessarily mean that the firm has been dissolved too but on the other hand when a firm is dissolved, it means that all the partnerships have been dissolved too.
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