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UNIT 15 DISSOLUTION OFPARTNERSHIP FIRMS

Structure

ObjectivesIntroductionDissolution of Partnership and Dissolution of Firm15.2.1 Dissoldtion of Parvership

1.5.2.2 Dissolution ~ f irm

Modes of Dis s o l~ t ionof Firm15.3.1

Dissolurion wi tho u~ he Order of Court

15.3.2 Dissolution hy tt Ordef of Cotlrt

Consequences of Dissolution of Firm15.4.1 Rights ~ fI Partner on Dissolution

15.4.2 Lii~biliticsof  a Pttrfncr on Dissolution

Settlement of AccountsLet Us Sum UpKey WordsAnswers to Check Your ProgressTerminal Questions

15.0 OBJECTIVES

After studying this unit you should be able to:

distinguish between dissolution of partne rship and dissolution of firmdescribe the modes of dissolution of firm

o explain the rights and liabilities of partners consequent to dissolution of firmo explain how accounts are settled among partners on dissolution.

1 INTRODUCTION

You have learnt about the formation of a partnersh ip firm and the provisions of theIndian Partnership Act relating to mutual relatiorlship of partners and their liabilitytowards third parties. In this unit, you will learn about the rules relating to dissolutionof l firm which includes modes of d i s s o lu t io~~right and liabilities of partners ondissolutio~iand the mode of scttlement of accounts among the partners.

15.2 DISSOLUTION OF PARTNERSHIP ANDDISSOLUTION OF FIRM

The Indian Partnership Act makes a distinction between dissolution of partnership an ddissolution of firm,

15.2.1 Dissolution of Partnership

Dissolution of pa rtnership simply means a change in the relation of the p art ner s. Sucha change is usually caused when a firm is reconstituted i . e . when a new partner isadmitted or when an cxistingpa rtner retires, dies, becomes insolvent or is expelled .The dissolution of partnership may or may not involve the dissolution of a firm. Afirm, aftcr a change in rclation of the partners, may decidc to continue as areconstituted firm. But, when a firm is dissolved, it necessarily involves thedissolutian of partnership.

For cxumplc A, B, C and D are carrying on trading business as a partnership firm.A, is declared insolvent by the court. The partnership between A, B, C and D comesto an end : u~da new partnership betwcen B, C and D orn s into existencc. This newpartnership between B. C and D shall be known as 'reconstituted firm'. Thus, ondeclaration o A 2 sinsolvent, the partnership s ~ i ~ n d sdissolved, but the firm continueswith the rcni ; i in~t~gi i r tnen B, C and D.

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Dissolution by notice:Whe n a partnership is at will, the firm may be dissolved byany

partner by giving notice in writing to all the other partners of his intention to

dissolve the firm.

If the partn ers has, in his notice, mentioned some specific date for the dissolutionof the firm, the firm is dissolved from that date . But if n o date has ben menti oned,

the firm is dissolved from the dat e when t he notice isc on~m unic a te d .

Its l~ou ld

benoted that a notice once given, cannot b e withdrawn without the consent of allother partners.

15.3.2 Dissolution by an Order of Court

Section 44 of the Partnership A ct deals with those situations where the court may,

on receipt of a petition by a par tner, ord er for th e dissolution of the firm, providedit is satisfied tha t in th e interest of justi ce, it is necessary to order for t he dissolution

of the firm. Under this section, the court can order even for premature dissolutionwhen the firm is created for a fixed period. When a petition is brought before thecourt, the court will give other partners a n opportunity t o put forward their defenceagainst passing an orde r for dissolution of firm. I t is only after evaluating all the

evidences before the cou rt that the court shall pass an order fordissallution

of thefirm. Let us now study the grounds on which a petition can be presented befor e the

court for obtaining a dissolution or der. These grounds ar e :

1 Insanity : When a pqrtner becomes insane, he is incapable of forming a rational judge ment. He nc e, it is tr ea te d as a va lid g ro und fo r the di sso lut ion of th e fir m. O n

this ground a suit may be filed either byally

other partner of the firm or by thenext friend of the partncr who has become of unsound mind. In either case thecourt may order dissolution of the firm. In th e case of a dormant part ner, however ,the court may not order dissolution because such a partner does

t,alre

an activepart in

thc

conduct of firm's business.

2 Permanent incapacity : When a partner has become permanently incapable ofperforming his duties as a partner, any other partner can file a

petition

for the

dissolution of firm. H owever , the court will not pass an order for dissolution if th eincapacity of a partner is only temporary . For example, a partner in a firm h ad anattack of paralysis. Another partner of the firm filed a petition for dissolution of

the , f irm.

The court refused to pass on order, according to doctors,pa~ralysis

was

of a tempor ary natur e an d the patient's condition was improving.Whitwell v.

 Arthur)

3 Misconduct:When a part ner, other than the partner suing, is guilty of misconductwhich is likely to adversely affect th e carrying on of th e business, th e court maydissolve the firm. In

deternlining

the gravity of misconduct to ord er dissolution,regard is to be had to t h c natu re of busincss. For exampl e, an immoral conduc t ofa partner in a firm of medical men may be considered an adequate ground for

dissolution but it may not be so in case of firm trading in Coal.

4 Persistent breach of agreement : W he n a partner, other than the partner suing,wilfully or persistently commits breach of agreement relating to th e managementof the affairs of the firm or he conducts himself in such a manner or th at it is notpracticable for ot her part ners to reasonably carry on the business in partnership

with him. Thus, embezzlement, fraudulent breach of trust, or keeping erroneous

aocounts may be sufficient ground for t he court t o order dissolution of the firm.

5 Transfer of interest:Th e court, at the instance of any other par tner, may dissolve

the firm when a partner has in any way

i

transferred

the

whole of his interest in a firm to a third party, or

ii

allowed his share to be charged on account of a decree passed by a courttowards payment of liabilities of that partner, or

iii

allowed hissharc

to be sold inthc

rccovcry ofarrcars

of land revenue.

6 Perpetual losses : W hc n the firm is continuously suffering losses and it is appare ntthat in futu re also the busincss cannot

be

carried on except at loss, thec our tm a y

order for thc dissolution of thc fir111at thc instance of any partncr .

7 Any other just and equitable ground: I f . onany

othe r ground, it can be proved tothe satisfaction o f

the court

that it is just andcquitnble lo

dissolve the firm, t he

Dissolution ofPartnership Firms

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Check Your Progress B

State whether th e following statements are True or False.

i) If a public notice of dissolution is not given the partner cont inues to beliable even after dissolution of the firm.

ii) If the partnership is for a fixed term and the firm is dissolved on accountof

thedeath

of a partner, the partner who had paid a premium to jointhe

firm,

is entitled to return ofp req i u m

proportionately.

iii) If the firm has been dissolved on account of fraud, only the third par tieshave the right to be indemnified.

iv) I n order to complete transactions begun before dissolution, partner s maycontinue to have the authority to bind the firm, even after dissolution.

v),

An insolvent partner is also liable for acts of the other partner s done........after the dissolution of th e firm.

vi) The sleeping partner is not liable for the acts of the other p artners doneafter the dissolution of t he firm.

15.5 SETTLEMENT O ACCOUNTS

The manner for settling partnership accoubts after dissolution of thefirm,

is usuallyprovided in the partnership contract itself. If, however, the partnership contract issilent on the matt er, the accounts of the dissolved firm shall b e settled according to

the rules given is sections 48, 49 and 55 of t he Ac t. These rules a re as follows :

1 Sharing of deficiency:According to Section 48(a) the losses including deficienciesof capital, shall be paid first out of profits next out of capital, and lastly, ifnecessary, by the partners individually in the proportion in which they wereentitled to share profits.

This implies tha t if the assets of the firm are insufficient to discharge t he liabilit iesof the firm, the partners shall bear the deficiency in their profit sharing ratio and

pay them out of their private assets, if necessary.

Example: A, B , C and D are partners in a business sharing profits and lossesequally. A dies and the firm is dissolved. On the date of dissolution it was found

that the capitals of A and B were Rs. 20,000 each and tha t of and D Rs. 10,000and Rs. 5,000 respectively. The outside liabilities stood at Rs. 6,000 and the totalvalue of assets at Rs. 41,000. Thus, the deficiency works out at Rs . 20,000

(61,000-41,000). This would be equally shared by B, C and D and the legal heirof A

i.e.,

Rs. 5,000 each.

2 Applicat ion of assets :The assets of t he firm including anysums

paid by thepartners to make up deficiencies of capital shall be applied in th e following order :

i) in paying off the debts of third part ies, .

ii) in paying to each partner ratab lywhat is

due tohim

from the firm-for advancesas distinguished from capital,

iii)

in paying to each partner ratably what is due to him on account of capit al, and

iv) the surplus, if any shall be divided among the partners in the proportion in

which they were entitled to share profits. [Section 48(b)l

Let us understand this with the help of an example. A, B and C w ere partners in afirm sharing profits and losses equally. The accounts show tha t, on the da te of

dissolution, partners' capital was A-Rs. 20,000, B-Rs. 10,000 and C- Rs. 2,000.A had advanced Rs. 2,000 as loan to the firm, the outside liabilities were

Rs. 13,000. The asset could realise Rs. 50,000. This amount shall be utilised first topay Rs. 13,000 of outside liability, next Rs, 2,000 to A for repayment of hi's loanthen Rs. 32,000 to A, B and C for their capital (Rs. 20,000 to A. Rs. 10,000 to B .

and Rs. 2,000 to C), and the remaining amount of Rs. 3,000 shall be shared equally

(profit sharing ratio) by A, and C.

Suppose. the assets realised Rs. 42.500 only resulting in a loss of Rs. 4,500

(Rs. 47,000- Rs. 42,500). This loss shall be shared by A, B and C equally reducingtheir capital balances to Rs. 18,500, Rs. 8,500 and Rs. 500 respectively. So, the

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amount of Rs. 42,500 shall be used as follows :

i)

Rs. 13,000 to pay outside liabilities

ii) Rs. 2,000 to pay A's loan, andiii) Rs. 27,500 to

pay

the capital balances of A, B and C.

DissolutionofPartnership Finns

3 Payment of firm s debts and separat e debts s partners:You know that the partnersare jointly and severally liable to pay the debts of the firm. This means that eventhe private assets of the partners can be utilised for payment of firm's debts , if

necessary. Not only t hat , the third party has the right to realise the whole amountfrom

any partner. This however is subject to the provision of Section 49 whichstates tha t the private assets of any partner shall be applied first, to pay his private

debts, and then , if t here is any surplus, it can be applied to pay the debts of th efirm, if necessary. Thus , partner 's p rivate assets can bc used fo r payment of firm'sdebts only after his private liabilities have been paid off and that too if firm's assetsare insufficient to pay firm's debts.

It should be noted that firm's assets are also used first for payment of firm'sliabilities and then the surplus, if any, can be used for payment of the private debtsof a partner only to the extent of his share in the property of the firm.

4 Loss arising from insolvency of a partner : If, on distribution of t he final amountof loss on dissolution, a

palmer s

capital account shows some deficiency, he shall

bring in the amounto t

deficiency in cash so that the other partners can be paidtheir amount s of capital. But , if t he partner whose

cspital

account shows deficiency

is insolvent, he ma) no t be able to bring in the necessary amount (fully or in part)

resulting in additional loss to othe r partners. In such a situation, the question arisesabout th e ratio in which the.other partner s are t o share such loss. This is done inthe light of a prominent English case of Garner v.  Murray which states that theloss arising from the deficiency of an insolvent partner's capital should be borneby the solvent partners in proportion to their respective capitals as they stood onthe date of dissolution. T o continue with the same example of A, B and C whoshare profits equally, if the assets realise Rs. 35,000 only this would result in a lossof Rs. 12,000 (Rs. 47,000-Rs. 35,000). When this amount of loss is shared by A ,B and C thei r capital balances will reduce to :A-Rs. 16,000, B-Rs. 6,000 and

C-Rs. (-)2,000. After paying Rs. 13,000 for outside debts and Rs. 2,000 for A'sloan, we a re left with Rs. 20,000 as against Rs. 22,000 to be

paid

to A-Rs. 16,000and 13-Rs. 6,000. The re is no problem if can bring in Rs. 2,000 due from him.

But if he becomes insolvent and only Rs. 500 can be realised from him, then ther ewill be a deficiency of Rs. 1,500 which will be sharcd by A and B in the ratio oftheir capitals

i .e.. 2:l

(not equally as per their profit sharing ratio). Thus their

capitals will stand reduced to A - Rs.15,000 (Rs. 16,000 - Rs. 1,000) and B-Rs. 5,500 (Rs. 6,000 - Rs. 500) which can now be paid to them with the help ofthe amo unt (R s. 20,000) left after paying outside debts and A's loan plus Rs. 500

realised fromC s

estate.

5 Sale o goodwill : According to Section 55, in settling the accounts of a firm afterdissolution, goodwill shall, subject to contract between the partners, be includedin theass cts, and it may be sold either separately or along with other property ofthe firm.

When, after dissolution of the firm, the goodwill of the firm has been sold, apartner may (i) car ry on a business competing with that of the buyer

i .e.,

the

partner of the dissolved firm can carry on the same business as that of the dissolvedfirm, and (ii) advertise such business.

But, subject to agreement between him and the buyer, he may not

a) use thk firm's name .

b) represent himself as carrying on the business of the old firm, orc) solicit the business from the customers of dissolved firm.

However, any p artn er may enter into an agreement with the buyer of goodwill thatsuch part ner will not carry on any business similar to that of the dissolved firmwithin a specified period or within the specified local limits. Such agreement shall

be valid if restrictions imposed a re reasonable as it would not be barred by Section27 of the Indian Contract Act, which deals with the agreements in restraint of ,trade.

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  Partnership Check Your Progress C

1 A, B and C were partners in a firm. Their profit sharing ratio was 4:3:3 Afterworking together for five years, they agreed to dissolve the firm . Afte r paying offthe debts of third parties and repaying the capital of the partners, there was aresidual balance of Rs. 50,000. What shall each partner get?

2 A, B, C and D are four partners in a firm sharing profits equally. On March 31,1990,

D

becomes insolvent and the partners decide to dissolve the firm. On thatdate their capital balances were Rs. 30,000, Rs. 20,000, Rs. 20,000 and Rs. 5,000respectively. The outside liabilities were Rs. 40,000. The assets realised Rs. 81,000.Calculate how much will be paid to A, B and C assuming nothing is realised fromD s estate.

3 State whether the following statements are True or False.

i) The private property of a partner has to be used first for the

payment of his private debts..........

ii) Any surplus left after payment of firm's debts is divided equallyamong all partners.

. . . . . . . .

iii) Losses, of the firm have to be paid first out of partner's privateproperty and then out of the firm's property.

... .....

iv) Any deficiency of par tner 's capital arising on the insolvency ofa partner is shared by other solvent partners in the light ofGarner v.  Murr ay rule.

v) When, after dissolution of the firm, goodwill of the firm has beensold, a partner may carry on business competing wit11 that ofthe buyer.

... ... .

15.6 LET US SUM UP

When there is a change in the relation of partners such as on admission of a newpartner or on retirement of a partner, it is called dissol~ltionof partnership and notthe dissolution of firm; The dissolution of firm invuhles the dissolution of partner shipbestweenall the partners. This may happen wit11 or without the intervention of thecourt. The court can order dissolution on

a

petit:ion by a par tner in case of (i) insanityof a partner, (ii) perm.anent incapacity of a partner, (iii) misconduct by a partner,(iv) persistent

breach of agreement by a partner, (v) transfer of the whole of hisinterest t o a third party, or (vi) perpetual losses in the firm's business. T he dissolutionwithout the order of the court takes place (i) by mutual agreement among partners ,(ii) on the happening of certain contingencies, (iii) by notice fronz a partner whenpartnership is at will, or (iv) by compulsory dissolutioi~if all (or all but one) partnersbecome insolvent or if the business of the firm becomes unlawful.

Consequent to dissolution of the firm, the partners are entitled to (i) equitabledistribution of firm's property, (ii) retu rn of premium oq premature dissolution,(iii)

restrain the use of firm's name and property, and (iv) certain rights wherepartnership is rescinded for fraud, etc. Th e partners continue to remain liable t o thirdparties for any acts done after dissolut ion if public notice is not given. In any case,the partner's authority to bind the firm, and mutual rights and obligations of thepartners continue so far may be necessary to wind up the affair of the firm, and to

complete transactions begun but unfinished at the time of the dissolution.

Section 48, 49 and 55 of the Act ley down detailed rules regarding settlement of,

accounts between the partner s. In the absence of any contract to the contrary, alllosses including deficiencies of capital must be paid first out of prof its, next out ofcapital , and lastly, if necessary, by contribution by all partners in their profit sharingratio. The assets of the firm, including sums contributed by partners t o make up thedeficiency of capital, shall be applied (i) in paying debts of the firm, (ii) in payingeach partner, rateably, for advances by him to the fi rm, (iii) in paying each p artne r,rateably ambunt due for his capital contribution, and (iv) the surplus in paying eachpartner according to his share in profits. If, however, a par tner becomes insolventand is unable to pay the amount due from h im, the solvent partners will share suchdeficiency in the ratio of their capitals as on the date of dissolution as pe r arner v.Mlrrray rule,

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PartnershipSOME USEFUL BOOKS

Gulshan,S.S.

and G.K. Kapoor. 1989,  Business La w, Wilay Eastern Limited,New Delhi (Chapter 3)

Kapoor, N.D. 1988.  Mercantil e La w, Sultan Chand Sons, New Delhi (ChapterPart 1, 2 and 3)

Kuchhal, M.C. 1989.  Mercantil e Law , Vikas Publishing House Private Limited,New Delhi (Chapters 21-24).

daheshwar i R.P. and Maheshwari, S.N. 1989.  Busin ess La w, National PublishingHouse, New Delhi (Block 3 Chapter s 1-4).

Shukla, M.C. 1987. A  Manual of  Mercanti le La w, S. Chand Co., New Delhi(Chapter 2).

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BB,OCK

UNIT NO. BPKPNrINBA II ElZIAL

d;camg.a-;a1

I,;Pw

o ~ C - O ~ I ~ R - ~ L C ~ S1

Essentialsok

aColitract

2OfLice

Acceptance

3 Capacity of Partics

2 Gcncrsl aw of C:onaQracts I1

5Collsideratioil

Legality of.Object

6 Void Agreement and Co1;tingent Contracts

7 Perforn lance [or Breach and Quasi Coritracts

3 Specific c:ontracls :mc l Arbitration

9 Indemnity and Guarantee

10 13ailinent And Pledge

11 Coiltract of A g c n ~ y

12 Carriage o r Goods

4 Partnershig~

13 Defiilitiolz and registratioil

14 Tights and Liabilities of Partners

15 Dissolution of PartnershipFiilll

5 Sale of Goods

16 Nature o l Colltract of Sale

17Conditiolis

ofWal.ranties

18 Transfer of Ownership and Delivery

19Rights and an Unpaid Seller