When the partnership between all the partners of a firm is dissolved, then it is called dissolution of a firm. It is important to note that the relationship between all partners should be dissolved for the firm to be dissolved. A dissolution of partnership changes the existing relationship between partners but the firm may continue its business as before. For example, when the firm consists of A, B and C and A retires, there is dissolution of partnership between A and others but partnership as between B and C is not dissolved. In such a case, there is dissolution of partnership between some of the partners only, but there is no dissolution of the firm.
Distinction Between Dissolution of Partnership and Dissolution of Partnership Firm:
| Dissolution of Partnership | Dissolution of Firm |
| Dissolution of a partnership refers to the discontinuance of the relation between partner and other partners of the firm. | Dissolution of firm implies that entire firm ceases to exist, including the relation among all the partners. |
| It is voluntary | It may be voluntary or compulsory. |
| Business of the firm continues as before. | Business of the firm comes to an end. |
| Relation between partners continues to exist but in a changed form. | Relation between partners comes to an end. |
| Books of accounts are not closed as there is only change in the existing agreement between the partners. | Books of accounts are closed as the business is discontinued. |
| the assets and liabilities are revalued. | all the assets are sold off in order to pay the liabilities of the business. |
Let us look at the legal provisions for the dissolution of a firm.
Dissolution of a Firm:
Section39:
Dissolution of a Firm:
The dissolution of a partnership between all the partners of a firm is called the “dissolution of the firm”.
According to s 39, when the dissolution of partnership between all the partners of the firm occurs, this is called dissolution of the firm. For example, when in a firm consisting of A, B and C all of them cease to be partners with one another, it amounts to dissolution of the firm.
A firm can be dissolved either voluntarily or by an order from the Court. Sections 40 to 43 deal with voluntary dissolution while Section 44 deals with the dissolution by a Court Order.
Dissolution by Agreement:
Section40:
Dissolution by Agreement:
A firm may be dissolved with the consent of all the partners or in accordance with a contract between the partners.
As partners can create partnership by making a contract as between themselves, they are also similarly free to end this relationship and thereby dissolve the firm by their mutual consent. When all the partners so agree, they may dissolve the firm at any time they like. According to Section 40 of the Indian Partnership Act, 1932, partners can dissolve the partnership by agreement and with the consent of all partners. Partners can also dissolve the partnership based on a contract that has already been made.
Sometimes there may have been a contract between the partners indicating as to when and how a firm may be dissolved, a firm can be dissolved, in accordance with such a contract. For instance, if the contract between the partners provides that on a 6 months’ notice by a partner the firm may be dissolved, then in accordance with this contract, a partner could give 6 months’ notice and get the firm dissolved.
Compulsory Dissolution:
Section41:
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.
Section 41 mentions certain events on the happening of which there is compulsory dissolution of the firm. Such dissolution is compulsory and if the partners want to continue in partnership by agreeing to the contrary, they cannot possibly do that. An event can make it unlawful for the firm to carry on its business. In such cases, it is compulsory for the firm to dissolve. However, if a firm carries on more than one undertaking and one of them becomes illegal, then it is not compulsory for the firm to dissolve. It can continue carrying out the legal undertakings.
According to Section 41, compulsory dissolution occurs under the following circumstances:
- According to 41(a) of the Act, when all the partners or all except one are adjudicated insolvent, the firm is compulsorily dissolved. When a partner is adjudicated insolvent, he ceases to be a partner. therefore, when all the partners or all except one adjudicated insolvent, there is no question of persons remaining partners with one another and therefore, there has to be dissolution of the firm.
- According to 41(a) of the Act, if the business of the though lawful when the firm came into existence, subsequently becomes unlawful, there has to be dissolution of the firm, this provision is based on the rules of the law of contract, for a valid contract the object and consideration have to be lawful as defined in section 23, Indian Contract Act further provides that when the contract to do an act becomes unlawful after making the contract, such a contract becomes void. for example, a number of persons join together as partners to sell liquor in a certain area. subsequently, the government imposes prohibition in that area and the sale of liquor is banned. as soon as the sale of liquor in that area becomes unlawful, the firm is dissolved.
- There is also compulsory dissolution of the firm if some event happens because of which it becomes unlawful for the partners, to continue as partners with each other. For example, two partners reside and carry on trade in two different countries. If war breaks between these two countries and the further commercial intercourse between the two partners thereby becomes against public and thus unlawful, there is compulsory dissolution of the firm.
Dissolution on the Happening of Certain Contingencies:
Section42:
Dissolution on the Happening of Certain Contingencies:
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.
Under Section 41, the dissolution of a firm is compulsory, but under Section 42, the dissolution of firm is not compulsory, Even on the happening of the contingencies mentioned in section 42, partners may agree not to dissolve the firm, and the business of the firm will be continued as before.
Section 42 mentions certain contingencies of which the firm is dissolved, unless there is a contract to the contrary. the contingencies mentioned in the section are:
Expiration of the Partnership Term:
When the partnership had been constituted for a fixed term, it continues obviously for the contemplated term and would be dissolved on the expiry of such term. if the partners so like they may agree to the contrary and continue the business even beyond that time. such an agreement may be express or implied. Unless otherwise agreed, the same mutual rights and duties continue for the extended period as they were there before the expiry of the term.
Completion of the Adventure:
Partnership created for some specific adventures or undertakings come to an end on the completion of such adventures or undertakings. thus, when the partnership was created specifically for carrying out contract of construction of a road and the road is completed, the partnership stood dissolved on completion of the contract. There can, however, be an agreement by which the partnership may not be dissolved and the business may be continued for some other adventures or undertakings after the completion of the earlier ones. unless otherwise agreed, the same mutual rights and duties between the partners continue in respect of their relationship for the new adventures and undertakings also.
Death of a Partner:
Death of a partner results in the dissolution of the firm unless the remaining partners agree to the contrary this provision is applicable when there are more than two partners in a firm, where on the death of them the others may agree to still continue the same old firm without its being dissolved. if there are only two partners and they agree that on the death of one of them, the firm would be compulsorily dissolved.
In Mt. Sughra v. Babu, AIR 1952 All 506 case, the Court held that when a firm consisted of just two partners, a term in their contract not to dissolve the firm on the death of one of them was invalid. Agarwala J. observed: “In the case of partnership consisting of only two partners, no partnership remains on the death of one of them and, therefore, it is contradiction in terms to say that there can be a contract between two partners to the effect that on the death of one of them, the partnership will not be dissolved but will continue.”
In Tax v. Seth Govindram, AIR 1966 S.C. 24 case, where A and B entered into a partnership in 1943 to work a sugar mill. it was agreed between them that on the death of either of them the firm should not be dissolved but the legal heir or nominee of the deceased should be taken in his place. A died in 1945. it was held that on A ‘s death, the original partnership between A and B has come to an end and the same partnership could not continue with A’s widow taking A’s place, or A’s son claiming that he become a partner in pursuance to the agreement between A and B in 1943. it was observed that there is a possibility that in pursuance of the wishes or the directions of the deceased partner, the surviving partner may enter into a new partnership with the heir of deceased partner, but that would constitute a new partnership and not the continuance of the old one.
In Shivraj Reddy and Brothers v S. Raghuraj Reddy, AIR 2002 N.O.C. 120 A.P. case, where the deed of partnership did not contain clause that remaining partner could carry on the business thereafter , held that on the death of partner the firm stood dissolved. as there was no proof of fresh agreement or business being done subsequently, the same would not tantamount to continue of earlier partnership
Insolvency of partner:
When a partner is adjudicated insolvent, he ceases to be a partner. the firm is also dissolved unless there is an agreement between the remaining partners to the contrary. This provision has to be read along with Sec. 41(a) which states that when all or all except one partner become insolvent, there is compulsory dissolution of the firm. if, therefore, there are only two partners and one of them is adjudicated insolvent, there is compulsory dissolution under section 41 and there is no question of there being a contract to the contrary making the firm to continue.
Dissolution by Notice of Partnership at Will
Section43:
Dissolution by Notice of Partnership at Will:
(1) Where the partnership is at will, the firm may be dissolved by any partner giving notice in writing to all the other partners of his intention to dissolve the firm.
(2) The firm is dissolved as from the date mentioned in the notice as the date of dissolution or, if no date is so mentioned, as from the date of the communication of the notice.
When the partnership is at will, as defined in section 7, the partners are not bound to remain as partners or continue the partnership for any fixed period. According to Section 43 of the Indian Partnership Act, 1932, if the partnership is at will, then any partner can give notice in writing to all other partners informing them about his intention to dissolve the firm. Such notice should be unambiguous and should show clear intention to leave the partnership.
It is to be noted that when the partnership was originally constituted for a fixed term, but the partners continue the business even after the expiry of the term, unless otherwise agreed, the partnership is now deemed to be a partnership at will. Although a partnership at will can be dissolved by a notice, there is, however, nothing which prevents the dissolution of such partnership under the other provisions of the Act. Thus, a partnership at will could also be dissolved by mutual consent, insolvency or death of a partner.
In dissolution of partnership at will, the firm is dissolved on the date mentioned in the notice. If no date is mentioned, then the date of dissolution of the firm is the date of communication of the notice.
In Harish Kumar v Bachan Lal, case, where there was a partnership at will entered into though partnership deed date 30th March 1954. On 18 th July 1971 the partners decided not to transact any business thereafter, and the continuance of the business was stopped. it was held that the date of dissolution of the firm was 18 th July 1971, when the continuance of further business was stopped, and the suit for rendition of accounts filed more than three years after the date of dissolution was barred by Article 5 of the Limitation Act.
Dissolution by the Court:
Section44:
Dissolution by the Court:
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, wilfully 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.
The need for dissolution by the court arises when all the partners do not want the dissolution. the partner or partners who want dissolution can file a suit and the other partners may contest the same. It may be noted that section 44, which permits a partner to invoke the jurisdiction of the court for the dissolution of the firm, is not subject to contract between the partners permitted under section 11 . therefore, a partner can always file a suit the dissolution of the firm if his case is covered under section 44. A suit for dissolution can be filed only when one or the other ground mentioned in section 44 is there. even when there is a valid ground for filing the suit for dissolution and a partner accordingly files the suit, the court is not bound to decree dissolution as this section clearly provides that “At the suit of partner, the court may dissolve the firm.”
a) Partner of Unsound Mind (Insanity):
When a partner becomes insane, he is incapable of forming a rational judgement. Hence, it is treated as a valid ground for the dissolution of the firm. On this ground a suit may be filed either by any other partner of the firm or by the next friend of the partner who has become of unsound mind. In either case the court may order dissolution of the firm. In the case of a dormant partner, however, the court may not order dissolution because such a partner does take an active part in the conduct of firm’s business
b) Permanent Incapacity of Partner:
When a partner has become permanently incapable of performing his duties as a partner, any other partner can file a petition for the dissolution of firm. However, the court will not pass an order for dissolution if the incapacity of a partner is only temporary.
In Whitewell v. Arthur case, where a partner in a firm has an ‘attack of paralysis’. Another partner of the firm filed a petition for dissolution of the, firm. The Court refused to pass the order because the doctors opined that ‘paralysis’ is of temporary nature and patient condition is improving.
c) Misconduct by Partner:
When a partner, other than the partner is guilty of misconduct which is likely to adversely affect the carrying on the business. The court may dissolve the firm. In determining the gravity of misconduct to order dissolution, regard is to be had to the nature of business. Example: An immoral conduct of a partner in a firm of medical men may be considered an adequate ground for dissolution but it may not be so in case of a firm trading in Coal.
d) Persistent Breach of Agreement:
When a partner, other than the partner suing, wilfully or persistently commits breach of agreement relating to the management of the affairs of the firm or he conducts himself in such a manner or that it is not practicable for other partners to reasonably carry on the business in partnership with him. Thus, embezzlement, fraudulent breach of trust, or keeping erroneous accounts may be sufficient ground for the court to order dissolution of the firm. One point to note is that the partner must be repeatedly breaching the contract, and continues to do so even after warnings. An on-off breach does not warrant the action. But persistent breaching will result in the court ordering the dissolution of the firm.
e) Transfer of interest:
A partner cannot transfer his shares and interests of the firm to another party without the permission of all the partners of the firm. He cannot admit a new partner in the partnership in the firm in such a manner. The court, at the instance of any other partner, may dissolve the firm when a partner has in any way
- transferred the whole of his interest in a firm to a third party, or
- allowed his share to be charged on account of a decree passed by a court towards payment of liabilities of that partner, or
- allowed his share to be sold in the recovery of arrears of land revenue.
f) Perpetual Losses:
When the firm is continuously suffering losses and it is apparent that in future also the business cannot be carried on except at a loss, the court may order for the dissolution of the firm at the instance of any partner.
g) Any other just and equitable ground:
The list given in Section 44 is not exhaustive. There can be other reasons for the dissolution of the firm. If the court is convinced the cause in the suit is justifiable and equitable, it will dissolve the firm. If on any other ground, it can be proved to the satisfaction of the court that it is just and equitable to dissolve the firm, the court may order dissolution of the firm. Examples of such ground are continued quarrelling between the partners, refusal to meet on matters of business. For example, if there is a deadlock between partners that is not showing signs of respite, the court can dissolve the firm.
Effect of Dissolution:
Continuing Authority of Partners:
- Authority of the partners continues even after dissolution so long as is necessary to wind up the business.
- each partner has an equitable lien over the firm’s assets which he can apply to pay the debts of the firm and to receive any amount due from partnership firm.
Continuing Liability of Partners:
- Liability of partners continues till the public notice of dissolution is given.
- Liability of partners continues for all things necessary for the winding up of the business. The partners may complete unfinished transactions
Right to Return of Premium:
- To buy entry into an existing firm, a new partner sometimes has to pay a premium to the existing partners in addition to any investment of capital.
- On dissolution, he is entitled to demand the return of a proportion of the premium if the partnership was for a fixed term and was dissolved before the expiry of that term
- However, in the following 3 cases, partner will not get the premium return – 1) Where the partnership was dissolved by agreement; or 2) misconduct of the party seeking return of the premium; or 3) death of a partner.
Settlement of Accounts on Dissolution (Order of Payment):
- Losses shall be paid first out of undistributed profits next out of capital, and lastly, if necessary, by the partners individually in the profit-sharing ratio.
- The assets of the firm including the losses contributed by the partner as above shall be applied in the following manner – 1) in paying outside creditors; 2) in repaying advances made by partners 3) in repaying capital to partners; and 4) if any amount is left then it shall be divided in PSR