Partnerships - Legal Aspects

Governance: Partnerships in India are governed by The Indian Partnership Act, 1932 and is complimentary to the Indian Contract Act.

Partnership is a concurrent subject- in the sense that it is administered by both the Central and State governments. So you will have to follow both Central Government and State Government laws when it comes to partnerships.

Unlimited Liability- a major disadvantage. Any partner can bind the firm and thus the firm faces all the liabilities the firm is bound to. If the company’s property is not enough, then personal property of the partners will be attached to pay the debts of the firm.

A partnership firm is not a legal entity. As per section (4) of Indian Partnership Act, 1932, 'partnership' is the relation between persons who have agreed to share the profits of a business carried on by all or any one of them acting for all.
But for tax purposes, a partnership firm is a legal entity.

Key Aspects to Consider in a Partnership Contract:

  • Partners are mutual agents- each partner is an ‘agent’ for other partners. Any one partners act can bind the entire firm. Thus partners are mutual agents.
  • Agreements can be written or oral. A written agreement is not necessary under the Partnership Act, but is recommended. However, you will need a written agreement for registration and tax purposes. A written agreement is advisable to establish existence of partnership and to prove rights and liabilities of each partner, as it is difficult to prove an oral agreement.
  • Sharing of profits is necessary. Under the Partnership Act, the firm will not be a partnership if one partner gets a fixed remuneration (regardless of profit). Interestingly, sharing of losses is not necessary, as well as sharing of capital. Sharing of revenue does not constitute as sharing of profits.
  • Mutual Agency is the real test of partnership.
    • Partnership at will- If there is no provision made between partners for the duration or determination of the partnership then the partnership is “partnership at will” (section 7). This means that any partner can dissolve the firm by giving notice to partners. The partnership deed may provide about the duration of the partnership or how the partnership will be brought to an end. If no provision made, then it is “partnership at will”. In case of ‘particular partnership’, the partnership comes to end when the venture for which it was formed comes to end.
    • Subject to the provision of the act, the mutual rights and duties of partners can be determined by a contract between partners which can be express or implied. Thus it will be important to enter into a written agreement to establish rights and duties or partners.
  • Every partner has the right to participate in business.
    • The property of the firm- subject to the provisions of the contract, the property of the firm includes all property, rights and interests of the firm originally brought into the stock of the firm.
    • Partner to be the agent of the firm
    • Implied authority- a partner is implied to be an agent of the firm and will act on the behalf of the firm
  • Partners are Jointly and Severally Liable for Acts of Firm- every partner is liable, jointly with other partners for all acts of the firm while he is a partner. ‘An act of a firm’ means any act or omission by all the partners, or by any partner or agent of the firm which gives rise to a right enforceable by or against the firm [section 2(a)]. ‘Joint and several’ means each partner is liable for all acts. Thus, if amount due cannot be recovered from other partners, any one partner will be liable for payment of entire dues of the firm.
    • Partner by holding out- ‘holding out’ means giving the impression that a person is a partner while he is not. If a person gives an impression to outsiders that he is partner of firm though he is not partner, he will he held liable as partner.
    • Minors admitted to benefits of partnership- if a person is a minor according to the law by which he is governed, he is legally not a partner. But with the consent of other partners he may be admitted to the benefits of the partnership.
  • Rights of minor- has a share of property and profits (depending on the agreement)
    • The minors share is liable, but not the minor himself.
  • Dissolution of firm- Without intervention by Court, a partnership can be dissolved by-
    • (a) By Agreement [section 40],
    • (b) Compulsorily in case of insolvency [section 41],
    • (c) dissolution in case of contingency [section 42],
    • (d) by notice if ‘partnership at will’ [section 43]
  • Dissolution of Partnership and Dissolution of Firm- the dissolution between all partners of the firm is called dissolution of the firm.
    • However, if one partner is changed/added/goes out, this is merely a reconstitution of the firm, not dissolution.
    • Mode of Dissolution- discussed above
    • Consequences- provided for in the Act
    • Sale of Goodwill- though intangible, as per section 14 of the Act, goodwill of the firm is part of the property of the firm. Goodwill is the reputation and connections which the firm establishes over time, together with circumstances which make the connections durable. This reputation enables to earn profits more than normal profits which a similar business would have earned. In settling the accounts of a firm after dissolution, the goodwill shall, subject to contract between the partners, be included in the assets, and it may be sold either separately or along with other property of the firm. [Section 55(1)].
    • Settlement of Accounts- only after all accounts have been settled, is the firm considered dissolved.
  • Though optional, registration of the firm is recommended.
    • Partner Cannot Sue if Firm is Unregistered- A partner cannot sue the firm or any other partner in the firm if the firm is unregistered. If third party files suit against a partner, he cannot claim of set off or institute other proceeding to enforce a right arising from a contract. Suit or claim or set off upto Rs. 100 can be made as per section 69(4) (b), but it is negligible in today’s standards. Criminal proceedings can be filed, but civil suit is not permissible.  
    • A Unregistered firm cannot Sue a Third Party- Only if the firm is registered, then only can it sue a third party in a civil suit [section 69 (2)]. Criminal proceedings can be filed, but civil suit is not permissible.

Thus in conclusion, a partnership has both advantages and disadvantages. Key points to remember are that partners are mutual agents, profits are shared and there is no separation of ownership and the firm. This means you face unlimited liability.