Formation of a partnership firm

A partnership may be formed by oral or by written agreement or an agreement of

partnership can be inferred from the conduct of the parties. The following basic facts
must be borne in mind by the persons desirous of entering into an agreement of
partnership:
 The successful working of a partnership depends upon mutual confidence and
utmost good faith among the partners because each partner is an agent of
others and binds them to the fullest extent of their fortunes.
 All the essential elements of a valid contract must present. There must be free
consent of the parties who must be competent to contract and the object of the
partnership should not be forbidden by law of immoral or opposed to public
policy.
 The mutual rights and obligation of partners must be discussed in details and
should be put in black and white in the shape of a “partnership deed” before
the partnership is actually started.
 The partnership should be registered as soon as it is formed with the registrar
of firms of the area.

Partnership Deed
The document in which the respective rights and obligation of the members of a
partnership are set forth is called a ‘partnership deed’.
The deed should cover the following points:
I. The name of the firm and the names and address of partners who compose it.
II. Nature of business and the town and place where it will carried on.
III. Date of commencement of partnership.
IV. The duration of partnership.
V. The amount of capital to be contributed by each partners and the methods of
raising finance in future if so required.
VI. The ratio of sharing profits and losses.
VII. Interest on partners’ capital, partners’ loan, and interest, if any, to be charged on
drawings.
VIII. Salaries, commissions etc, if any, payable to partners.
IX. The method of preparing accounts and arrangement for audit and safe custody of
cash etc.
X. Division of task and responsibility, i.e. the duties, power and obligations of all the
partners.
XI. Rules to be followed in case of retirement, death the admission of a partner.
XII. Expulsion of partners in case of gross breach of duty or fraud.
XIII. Can Partner carry on a competing business or any other business whether
competing or not. Section 11(2) clearly provides that the Deed may provide that a
partner shall not carry on any business other than that of the firm while he is
partner, notwithstanding anything contained in section 27 of the Indian contract
Act where agreements in restraint of trade are void.
XIV. The circumstances under which the partnership will the partnership will stand
dissolved.
XV. Arbitration in case of dispute among the partners.
The terms laid in the Deed may be varied by consent of all the partners, and such consent
may be expressed or may be implied by a course of dealing.

Duration of Partnership

From the duration point of view the partnerships may be classified into the following two
categories:

 Partnership at will: - According to section 7 of partnership act Where no

provision is made by contract between the partners for the duration of their
partnership, or for the determination of their partnership, the partnership is
"partnership-at-will".
 Particular partnership: - According to section 8 of partnership act A person
may become a partner with another person in particular adventures or
undertakings.

Kinds of partners
There may be various types of partners in a partnership firms which are as follows:
1) Active or Actual Partners: - Partners who take an active part in the conduct of
the partnership business are called Active or Actual partners.
2) Sleeping or dormant partners: - Sometimes, however, there are persons who
merely put in their capital (or even without capital they may partners) and do not
take active part in the conduct of the partnership business. They are known as
‘Sleeping’ or ‘dormant’ partners.
3) Silent partners: - Those who by agreement with other partners have no voice in
the management of the partnership business are called ‘silent’ partners.
4) Partner in profits only: - A partner who has stipulated with other partners that he
will be entitled to a certain share of profits without being liable for the losses, is
known as a ‘partner in profits only;.
5) Sub-partner: - When a partner agrees to share his share of profits in partnership
firm with an outsider, such an outsider is called sub-partners.
6) Partner by estoppels or holding out: - According to section 28 of partnership act
If a person represents to the outside world by words spoken or written or by his
conduct or by lending his name, that he is a partner in certain partnership firm, he
is the estopped from denying his being a partner, and is liable a partner in that
firm to any one who has on a faith of such representation granted to the firm.
Dissolution of partnership firm
The Partnership act distinguishes between: -

 Dissolution of firm.
 Dissolution of partnership.

Section 39 of Partnership act provides that the dissolution of partnership between all the
partners of a firm is called the dissolution of a firm.
When one or more partners cease to be partners of the firm but others continue the
business in partnership it is called ‘dissolution of partnership’.

Modes of dissolution of a firm: -

1. By agreement: - According to section 40 of Partnership act “A firm may be
dissolved with the consent of all the partners or in accordance with a contract
between the partners.”
2. By Notice: - Where the partnership is at will according to section 40 of
partnership act, the firm may be dissolved by any partner giving notice in writing
to all the other partners of his intention to dissolved the firm.
3. On the happening of certain contingency: -According to section 42 of
partnership act 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 a partner; and (d) by the adjudication of a partner as an insolvent.
4. 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 : Provided that,
where more than one separate adventure or undertaking is carried on by the firm, the
illegality of one or more shall not of itself cause the dissolution of the firm in respect
of its lawful adventures and undertakings.
5. Dissolution By court: - According to section 44 of Partnership act at the suit of a
partner, the Court may dissolve a firm on any of the following grounds, namely:-
(a) that a partner has become of unsound mind, in which case the suit may be
brought as well by the next friend of the partner who has become of unsound mind as by
any other partner;
(b) That a partner, other than the partner suing, has become in any way
permanently incapable of performing his duties as partner;
(c) 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) that a partner, other than the partner suing, willfully or persistently commits
breach of agreements relating to the management of the affairs of the firm of the conduct
of its business; or otherwise so conducts himself in matters relating to the business that it
is not reasonably practicable for the other partners to carry on the
Business in partnership with him;
(e) that a partner, other than the partner suing, has in any way transferred the
whole of his interest in the firm to a third party, or has allowed his share to be charged
under the provisions of rule 49 of Order XXI of the First Schedule to the Code of Civil
Procedure, 1908, or has allowed it to be sold in the recovery of arrears of land revenue or
of any dues recoverable as arrears of land revenue due by the partner;
(f) That the business of the firm cannot be carried on save at a loss; or (g) on any
other ground which renders it just and equitable that the firm should be dissolved.

Consequence of Dissolution: -
1. Continuing liability of partners after dissolution: - According to section 45 of
partnership act (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 the dissolution, until
public notice is given of the dissolution : Provided that the estate of a partner who
dies, or who is adjudicated an insolvent, or of a partner who, not having been
known to the person dealing with the firm to be a partner, retires from the firm, is
not liable under this section for acts done after the date on which he ceases to be a
partner. (2) Notices under sub-section (1) may be given by any partner.
2. Continuing authority of partners for purposes of winding up: - According to
section 47 of partnership act After the dissolution of a firm the authority of each
partner to bind the firm, and the other mutual rights and obligations of the
partners, continue notwithstanding the dissolution, 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 : Provided that the firm is in no
case bound by the acts of a partner who had been adjudicated insolvent, but this
proviso does not affect the liability of any person who has after the adjudication
represented himself or knowingly permitted himself to be represented as a partner
of the insolvent.
3. Right of partners to enforce winding up: - According to section 46 of
partnership act On the dissolution of a firm every partner or his representative is
entitled, as against all the other partners or their representatives, 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 or which representatives
according to their rights.
4. Liability to share personal profits: -According to Section 50 of partnership act
so long as the affairs of the dissolved firm are in process of winding up, it is still
the duty of every partners not to make any personal profit out of transactions
concerning the firm. A partner therefore must account to the firm for every benefit
so derived by him and must share it with other partners.
5. Return of premium: -According to section 51 partnership act Where a partner
has paid a premium on entering into partnership for a fixed term, and the firm is
dissolved before the expiration of that term otherwise than by the death of a
partner, he shall be entitled to repayment of the premium or of such part thereof as
 may be reasonable, regard being had to the terms upon which he became a
partner, and to the length of time during which he was a partner, unless - (a) the
dissolution is mainly due to his own misconduct, or (b) the dissolution is in
pursuance of an agreement containing no provision for the return of the premium
or any part of it.
6. Right where partnership contract is rescind for fraud etc: - According to
section 52 of partnership act Where a contract creating partnership is rescinded
on the ground of fraud or misrepresentation of any of the parties thereto, the party
entitled to rescind is, without prejudice to any other right, entitle - (a) to a lien on,
or right of retention of, the surplus of the assets of the firm remaining after the
debts of the firm have been paid, for any sum paid by him for the purchase of a
share in the firm and for any capital contributed by him; (b) to rank as a creditor
of the firm in respect of any payment made by him towards the debts of the firm;
and (c) to he indemnified by the partner or partners guilty of fraud or
misrepresentation against all the debts of the firm.
7. Right to impose restriction: - According to section 53 of partnership act After a
firm is dissolved, every partner or his representative may, in the absence of a
contract between the partners to the contrary, restrain any other partner or his
representative from carrying on a similar business in the firm-name or from using
any of the property of the firm for his own benefit, until the affairs of the firm
have been completely wound up : Provided that where any partner or his
representative has brought the goodwill of the firm, nothing in this section shall
affect his right to use the firm-name.
According to Section 54 of partnership act Partners may, upon or in anticipation
of the dissolution of the firm, make an agreement that some or all of them will not
carry on a business similar to that of the firm within a specified period or within
specified local limits.

Mode of setting Accounts upon Dissolution

In settling the accounts of a firm after dissolution, the following rules shall, subject to
agreement by the partners, be observed :
(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 any sums 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; (iii) in paying to each
partner rate ably 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.
Sales of Goodwill after dissolution

According to section 55 of partnership act the rules relating to sale of goodwill upon
dissolution of a firm are as follows:
1. While winding up the affairs of the firm after dissolution, the goodwill shall,
subject to contract between the partners, be included in the assets, and it may sold
either separately or along with other property of the firm.
2. After the sale of goodwill any partner of the dissolved firm a) Can carry on a
business competing with that of the buyer’s goodwill and b) can advertise such
business. But any partners of the dissolved firm may make an agreement with the
buyer that such partner will not carry on a business similar to that of the firm with
a specific period or within specified local limits, provided by restrictions imposed
are reasonable.
3. In the absence of a contract to the contrary, the seller of goodwill, that is partners
of the dissolved firms cannot 1. Use the firm name 2. Represents themselves as
carrying on the business of the old firm, and 3. Cannot solicit the customers of the
old firm.