Definition of Partnership

Partnership Firms in India are governed by the Indian Partnership Act, 1932.
As per Section 4 of the Indian Partnership Act: -

“Partnership is 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”

Thus, as per the above definition, there are 5 elements which constitute of a
partnership namely: (1) There must be a contract; (2) between two or more
persons; (3) who agree to carry on a business; (4) with the object of sharing
profits and (5) the business must be carried on by all or any of them acting for
all.

5 Essential Elements of a Partnership Firm

All of 5 elements mentioned above must co-exist in order to constitute a

partnership. If any of these is not present, there cannot be a partnership. These
5 essential elements of a partnership firm are explained below in detail.

1. Contract for Partnership

Partnership is the result of a contract. It does not arise from status, operation
of law or inheritance. Thus, at the time of death of the father, who was a partner
in the partnership firm, the son can claim share in the partnership property but
cannot become a partner unless he enters into a contract for the same with other
persons concerned.

Similarly, the members of a HUF carrying on a family business cannot be

called partners for their relation arises not from any contract but from status.
Thus, a “contract” is the very foundation of partnership.

2. Maximum No. of Partners in a Partnership is 20

Since partnership is the result of a contract, at least two people are necessary
to constitute a partnership. The Indian Partnership Act, 1932 does not mention
anything about the maximum no. of partners in a partnership firm but as per
the Companies Act, a partnership consisting of more than 10 persons for a
banking business and more than 20 persons for any other business would be
considered as illegal. Hence, these should be regarded as the maximum limits
to the number of partners in a partnership firm.

Only, the persons competent to contract can enter into a contract of

partnership. Persons may be natural or artificial. A Company may, being an
artificial legal person, enter into a contract of partnership, if authorized by its
Memorandum of Association to do so. There could even be a partnership
between 2 companies (Steel bros & Co. Ltd. Vs Commissioner of Income Tax)

A partnership firm, since it is not recognized as a legal person having a separate

legal entity from that of its partners cannot enter into contract of partnership
with another partnership firm or individuals (Duli Chand vs Commissioner of
Income Tax)

When a partnership firm (under a firm name) enters into a contract of

partnership with another partnership firm or individual, in that case, in the eyes
of the law the members of the firms or firm become partners in their individual
capacity (Jadavji Narsidas & Co. Vs Commissioner of Income Tax)

3. Carrying on of Business in a Partnership

The third essential element of a partnership is that the parties must have agreed
to carry on a business. The term “business” is used in its widest sense and
includes every trade, occupation or profession. Therefore, if the purpose us to
carry on some charitable work, it will not be a partnership.

Similarly, if a number of persons agree to share the income of a certain

property or to divide the goods purchased in bulk amongst them, there is no
partnership and such persons cannot be called partners because in neither case
they are carrying on a business.

Thus, where A and B jointly purchased a tea shop and incurred additional
expenses for purchasing pottery and utensils for the job, contributing the
money in equal proportions and then leased out the shop on rent which was
shared equally by them , it was held that they are only co-owners and not
partners as they never carried on any business.

4. Sharing of Profits

This essential element provides that the agreement to carry on business must
be with the object of sharing profits amongst all the partners. Thus, there would
be no partnership where the business is carried on with a philanthropic motive
and not for making a profit or where only one of the persons is entitled to the
whole of the profits of the business. The partners may however, agree to share
the profits in any ratio they like.

Sharing of losses not necessary

To constitute a partnership, it is not essential that the partners should agree to
share the losses (Raghunandan vs Harmasjee). It is open to one or more
partners to agree to bear all the losses of the business.

Moreover, the manner in which the profits/losses are to be shared should

be expressly stated in the partnership deed. In the absence of this being
mentioned in the partnership deed, the provisions of the Partnership Act, 1932
would apply which state that the profits/losses should be distributed equally
among all partners.

However. it must be noted that although a partner may not share in the losses
of a business, yet his liability towards the outsiders shall be unlimited. In case
the partners intent to limit their liability towards the outsiders, a new concept
of partnership i.e. Limited Liability Partnerships have been introduced in
India. In a Limited Liability Partnership, the liability of the partners towards
the outiders is limited.

5. Mutual Agency in a Partnership

The fifth element in the definition of partnership provides that the business
must be carried on by all the partners or any (one or more) of them acting for
them all, i.e. there must be a mutual agency.

Thus, every partner, is both an agent and principal for himself and other
partners, i.e. he can bind by his acts the other persons and can be bound by the
acts of other partners. The importance of the element of mutual agency lies in
the fact that it enables every partner to carry on the business on behalf of
others.

Dissolution of Partnership Firm and Settlement of Accounts

Dissolution of partnership firm is a process in which relationship between partners
of firm is dissolved or terminated. If a relationship between all the partners of firm
is dissolved then it is known as dissolution of firm. In case of dissolution of
partnership of firm, the firm ceases to exist. This process includes the discarding
and disposing of all the assets of firm or and settlements of accounts, assets, and
liabilities. Learn more about Dissolution of partnership firm, legal provisions, and
settlement of accounts.
Dissolution of Partnership Firm

As we know that after the dissolution of partnership firm the existing relationship
between the partner’s changes. But, the firm continues its activities. The dissolution
of partnership takes place in any of the following ways:

1. Change in the existing profit sharing ratio.

2. Admission of a new partner
3. The retirement of an existing partner
4. Death of an existing partner
5. Insolvency of a partner as he becomes incompetent to contract. Thus,
he can no longer be a partner in the firm.
6. On completion of a specific venture in case, the partnership was formed
specifically for that particular venture.
7. On expiry of the period for which the partnership was formed.
Section 39 of the Indian Partnership Act 1932 states that the dissolution of
partnership firm among all the partners of the partnership firm is the Dissolution of
the Partnership Firm. The dissolution of partnership firm ceases the existence of the
organization.

After this, the partnership firm cannot enter into any transaction with anybody. It
can only sell the assets to realize the amount, pay the liabilities of the firm and
discharge the claims of the partners.

However, the dissolution of a firm may be without or with the intervention of the
court. It is noteworthy here that the dissolution of partnership may not necessarily
result in the dissolution of the firm.

But, dissolution of partnership firm always results in the dissolution of the

partnership.

Following are the ways in which dissolution of a partnership firm takes place:
1. Dissolution by Agreement

A firm may be dissolved if all the partners agree to the dissolution. Also, if there
exists a contract between the partners regarding the dissolution, the dissolution may
take place in accordance with it.

2. Compulsory Dissolution

In the following cases the dissolution of a firm takes place compulsorily:

• Insolvency of all the partners or all but one partner as this makes them
incompetent to enter into a contract.
• When the business of the firm becomes illegal due to some reason.
• When due to some event it becomes unlawful for the partnership firm
to carry its business. For example, a partnership firm has a partner who
is of another country and India declares war against that country, then
he becomes an enemy. Thus, the business becomes unlawful.

3. When certain contingencies happen

The dissolution of the firm takes place subject to a contract among the
partners, if:

• The firm is formed for a fixed term, on the expiry of that term.
• The firm is formed to carry out specific venture, on the completion of
that venture.
• A partner dies.
• A partner becomes insolvent.

4. Dissolution by Notice

When the partnership is at will, the dissolution of a firm may take place if any one
of the partners gives a notice in writing to the other partners stating his intention to
dissolve the firm.

5. Dissolution by Court

When a partner files a suit in the court, the court may order the dissolution of the
firm on the basis of the following grounds:
 • In the case where a partner becomes insane
• In the case where a partner becomes permanently incapable of
performing his duties.
• When a partner becomes guilty of misconduct and it affects the firm’s
business adversely.
• When a partner continuously commits a breach of the partnership
agreement.
• In a case where a partner transfers the whole of his interest in the
partnership firm to a third party.
• In a case where the business cannot be carried on except at a loss
• When the court regards the dissolution of the firm to be just and
equitable on any ground

Settlement of Accounts
In a case where the partners do not have an agreement regarding the dissolution of
the firm, the following provisions of the Indian Partnership Act 1932 will apply:

• The firm will pay the losses including the deficiency of capital firstly
out of the profits, secondly out of the partner’s capital and lastly by the
partners individually in their profit sharing ratio.
• The firm shall apply its assets including any contribution to make up
the deficiency firstly, for paying the third party debts, secondly for
paying any loan or advance by any partner and lastly for paying back
their capitals. Any surplus left after all the above payments is shared by
partners in profit sharing ratio.

Difference between the Dissolution of Partnership and Dissolution of Firm

Dissolution of
Basis Dissolution of Firm
Partnership
 The business of the The business of the
1. Closure of business firm continues there is firm gets
no closure. discontinued.

There is a revaluation
of assets and
The liabilities are
2. Settling of assets liabilities. Hence, they
paid-off and assets are
and liabilities are shown at revalued
realized.
figures in the Balance
Sheet.

In this case, there is no

intervention by the
court as the
The court may or may
3. Intervention by dissolution of
not intervene in this
court partnership takes
case.
place by the mutual
consent of all the
partners.

The relationship
between the partners The relationship
4. Relationship continues to exist between the partners
though it may change ceases to exist.
its form.

There is no closure of The books need

5. The closing of
books as the business closure as the business
Books of accounts
continues. ceases to continue.