Meaning of Partnership / Partnership firm
When any business is carried on jointly by a group of persons for mutual benefit, it is known as Partnership or Partnership firm. In other words, A Partnership is an association of two or more persons to carry on, as co-owners of a business and to share equal or agreed profits and losses.
Definition of Partnership
According to L.H.Haney “ the relationship between persons who agree to carry on a business in common with a view to private gain.”
Section 4 of the Indian Partnership Act , 1932 defines Partnership as “ the relationship between persons who have agreed to share the profits of a business carried on by all or any of them acting for all.”
Essentials/features/characteristics of Partnership
Mutual agreement : Partnership is formed by an agreement between two or more individuals. However , the agreement by which Partnership is created may be oral or in writing , but the usual practice is in writing to make a prof for future reference.
Sharing of profits : The agreement between the partners to carry on business must be profit sharing among all the partners. The partners may share the profits in any ratio as per the agreement .
In the absence of any agreement to the agreed ratio of profits sharing , the profits must be shared equally as per the Indian Partnership Act , 1932 . It is open to one or more partners to bear all the losses of the business of the firm , if nothing is specified in the partnership agreement regarding loss sharing , the partners should share the losses equally .
Lawful business : The business to be carried on by the partners must be lawful , and not illegal , immoral or opposed to public policy . The term business generally conveys the idea of running a business involving numerous transactions .
Mutual agency : The business of partnership may be carried on by all the partners or any of them acting for all. This means that a partner binds all other partners by his acts and omissions provided that these acts are done for the firm and in the ordinary course of the business.
In other words , partnership represents extension of agency/company principle .
An association of two or more persons : There must be two or more persons to constitute a partnership , as a single person cannot enter partnership with himself . The maximum number of persons who can be partners in a firm is ten in the case of a firm carrying on banking business , and twenty in case of a firm carrying on any other business .
Unlimited liability of the partners : The liability of the partners are unlimited . That means , even the private assets of the partners are liable for the debts of the firm to an unlimited extent . In case an obligation arises, not only the assets of the company can be taken, but also the private property of the partners for the payment of the debts of the company to the third parties . The creditors can claim their contributions from one of the partners or from all the partners. The partners are individually and collectively responsible.
No separate entity : A partnership firm and its partners are regarded as one and the same person . A partnership firm has no separate legal entity apart from the partners composing it . Partnership firm does not enjoy a separate existence of its own which is different from those of its members . Legally, the firm is a collective name for all the partners taken together .
Utmost good faith : The very basis of the association is good faith and mutual trust. Each partner must act honestly and give appropriate accounts to other partners. The partnership can not work if there are suspicions among the partners.
Restriction on transfer of shares : No member can sell or transfer their shares to anyone without the consent of the other partners. If a partner does not wish to continue in the company, he can give a notice of dissolution of the company.
Types / kinds of partnership
On the basis of liability, partnership may be divided into two classes . They are
- General partnership or unlimited partnership
- Limited partnership
General partnership : A partnership which has only general partners is called “General partnership” . The partners whose liability is unlimited are called “General partners” .
Limited partnership : A partnership which has one or more limited partners in addition to one or more general partners is called “limited partnership” . The partners whose liability is limited to the extent of capital contributed by them are called “limited partners” or “special partners” .
Features of limited partnership
- In a limited partnership, it is a condition that there should be at least one general partner and one limited partner. The maximum number of partners permitted in a limited partnership is the same as in case of a general partnership .
- The liability of the general partners is unlimited , while the liability of the limited partners is limited to the amount of capital contributed by them .
- A limited partner cannot bind the firm by his own acts .
- A limited partner cannot withdraw any part of his capital during the continuance of the firm .
- A limited partner cannot transfer his share in the partnership to others without the consent of the general partners .
- A limited partner enjoy certain rights . He is entitled to receive a share of the profits of the firm . He can inspect the books of the firm .
- The death , bankruptcy or lunacy of a limited partner will not dissolve the firm .
- A limited partnership must be registered .If it is not registered , it will be regarded as a general partnership with unlimited liability .
- In addition to the usual advantages of the general partnership , a limited partnership enjoys certain additional advantages . The additional advantages of a limited partnership are :
- This form of partnership helps in obtaining capital from persons who are not willing to assume unlimited liability .
- It is more stable than a general partnership , because its continuity is not affected by the death , bankruptcy or lunacy of the limited partners .
Drawbacks of limited partnership are :
- It is subject to legal formalities . Registration of limited partnership is compulsory .
- Secrecy of business matters cannot be maintained in a limited partnership because of compulsory registration and consequent publicity of its affairs .
- The limited liability of the limited partners reduces the credit-worthiness of the firm .
- In a limited partnership , the general partners , who take part in the management of the business , may exploit the limited partners who have no voice in the management of the partnership business .
- The limited partners cannot withdraw their capital during the continuance of the firm .
From the point of view of duration , partnerships may be classified into three kinds . They are :
- Partnership for affixed term
- Particular partnership
- Partnership at will
Partnership for a fixed term : When a partnership is formed for a fixed term (i.e., for a particular period) , it is called partnership for a fixed term . A partnership formed for a fixed period may be continued even after the expiry of the fixed period , if the partners decide to continue their partnership after the expiry of the fixed period , the rights obligation of the partners will remain the same as before , and the partnership will become partnership at will .
Particular partnership : When a partnership is formed for a particular venture (i.e., undertaking or business) , it is called particular partnership . A partnership formed for a specified or particular venture comes to an end on the completion of the specified venture . A particular partnership can be continued even after the completion of the particular venture , the rights and obligations of the partners will remain the same as before , and the partnership will become partnership at will .
Partnership at will : Where no provision is made in the contract between the partners for the duration of their partnership or for the termination of their partnership , the partnership is called “partnership at will”. As the duration is not fixed in the case of partnership at will , the partnership at will is uncertain and indefinite . Such a partnership can be dissolved at any time at the will and pleasure of any partner . It can be dissolved by any partner by giving a notice , in writing , to the other partners , of his intention to dissolve the firm .
Types / kinds of partners
Active , Actual , Working or Ostensible partner : A partner who takes an active part in the conduct and management of the business of the firm is called an active , actual , working or ostensible partner . An active partner is a full fledged firm . He is an agent of the other partners in the normal course of business . He must give a public notice of his retirement from the firm , of course , after his retirement , so as to free himself from liability for the acts of the company carried out after his retirement.
Sleeping , dormant or financing partner : A partner who merely contributes capital and shares the profits or losses of the firm , but does not take active part in the conduct and management of the partnership business is called a sleeping , dormant or financing partner . He is not known to the outside world as a partner , he is liable along with the other partners for all the acts of the firm like an undisclosed principle . He need not give public notice of his retirement after retirement so as to free himself from liability for the acts of the company carried out after his retirement.
Secret partner : If a person is a partner of the firm , but the fact of his being a partner is not disclosed to outsiders , he is called as secret partner . A secret partner is liable for all the debts of the firm to an unlimited extent .
Nominal partner , Fictitious partner or partner in name only : A partner who neither contributes capital nor shares the profits or losses of the firm nor takes any active part in the conduct of the business of the firm , but merely lends his name to the firm is called a nominal , fictitious partner , or a partner in name only . But he is known to the outside world as a partner , as he allows his name to be used as a partner . He is liable to outsiders along with the other partners for all the acts of the firm to an unlimited extent .
Partner in profits only : A partner who , as per the partnership agreement , is entitled to a share in the profits of the firm , but is not liable to contribute towards the losses of the firm is called a partners in profits only . However he is liable to third parties , along with the other partners , for all the acts of the firm to an unlimited extent .
Partner by Estoppel : Where a partner , by words of mouth or by his conduct , gives an impression to the outside world that he is a partner in a certain partnership firm , though he is not really a partner , he is estoppel or precluded from denying the role which he has assumed , and he is held liable as a partner of the firm to any outsider who has granted credit or loan to that firm on the faith of his representation . Such a partner is called partner by estoppel .
Partner by holding out : A person is held out as a partner though he is not a partner . He comes to know that his name is getting circulated as a partner of the firm but he intentionally keeps quite/silent over the matter . Then he is called a partner by holding out . A partner by holding out is liable to third parties who grant credit to the firm with a belief that he is a partner .
Minor Partner or minor admitted to the benefits of the partnership : It is true that a minor cannot become a full-fledged partner of a firm . But , as per section 30(1) of the partnership Act , he may be admitted to the benefits of a partnership with the consent of all the partners by an agreement executed by his guardian on his behalf with the other partners .
The following points has to be noted in admitting a minor into a partnership :
- A minor cannot be full-fledged partner of a firm , because he is incompetent to contract .
- He may , however , be admitted to the benefits of a partnership .
- He can be admitted to the benefits of a partnership with the consent of all the partners .
- If the minor is admitted to the benefits of a partnership , the guardian of the minor has to enter into an agreement with the other partners on behalf of the minor .
- There must be a partnership before a minor can be admitted to their benefit.
- There cannot be a partnership consisting of only one adult partner and one or more minors .
The status of a minor , admitted to the benefits of partnership , after attaining majority , is as follows :
- After attaining the age of 18 years , a minor becomes a major .
- According to the Indian Partnership Act , 1932 , a minor admitted to the benefits of partnership , within a six months of attaining majority , must give a public notice intimating whether he will continue to a partner or not .
- If he does not give a public notice of his intention , he will be presumed to have decided to continue as the partner of the firm .
If a minor decides to continue as a partner of the firm , as a major partner :
- He will have to bear unlimited liability for all the debts incurred by the firm right from the date of his being admitted to the benefits of partnership .
- He will continue to share the profits of the firm as before .
- He will also have to share the losses of the firm .
- If a minor chooses not to become a partner ( i.e., major partner )
- His rights and liabilities will continue to be those of a minor partner up to the date of the notice given by him .
- He will not be liable for any debts of the firm after the date of notice .
- He has the right to file a suit in a court for his share in the profits and assets of the firm .
A partnership is formed by an agreement between the persons . The partnership agreement between the partners may be oral or written . When a partnership agreement is put in writing , duly stamped and signed by all the partners , the document containing the partnership agreement is called the partnership deed or the articles of partnership . The partnership deed contains all the terms and conditions of the partnership , and every partner is bound by the terms and conditions laid down in the partnership deed .
The terms and conditions usually found in a partnership deed are as follows :
- The name of the firm .
- The names and addresses of the partners .
- The nature of the business which the firm proposes to undertake .
- The principal place of business and the branches of the firm .
- The date of commencement of partnership .
- The duration of the partnership .
- The amount of capital to be contributed by each partner and the manner of contribution .
- The manner in which additional capital is to be introduced by the partners in future .
- The amount of withdrawal (drawings ) that can be made by each partner and the manner of withdrawal .
- If any interest is to be allowed on partners capitals , the rate of interest chargeable on partners drawings .
- The rate of interest payable on partners loans , if any .
- The amount of salary , commission or any other remuneration payable to any partner for any extra work done for the firm .
- The ratio in which the profits or losses of the firm are to be shared among the partners .
- The manner in which the work of the management is divided among the partners .
- The rights , duties and liabilities of the partners .
- How the accounts of the partners should be kept and audited .
- Expulsion of a partner in case of gross breach of duty or fraud .
- The methods and circumstances of dissolution of the firm .
- The method of settlement of accounts on retirement or death of a partner .
- The mode of settlement of accounts on the dissolution of a firm .
Formation of partnership
A partnership may be formed directly or may be developed by converting an existing sole trading concern into a partnership by taking one or more persons as partners . A partnership firm may be formed easily , as no legal formalities are required for its formation . Even the registration of a partnership firm is not compulsory.
Registration of a partnership firm :
The Indian Partnership Act of 1932 provides for the registration of a firm . But the registration of a partnership firm is not made compulsory .It is left to the discretion or option of the partnership firm .
The registration of a partnership firm can be effected at any time . For the registration of a firm , a statement in the prescribed form must be submitted to the registrar of firms along with the necessary registration fee . The statement should be signed by all the partners or by their duly authorized agents .
The statement should contain the following particulars .
- Name of the firm .
- Establishment place of business of the firm .
- Names the other places where the firm operates .
- Date on which each partner joined the firm .
- Names and addresses of all the partners .
- Duration of the firm .
Any change in the above particulars after the registration must be brought to the notice of the registrar of firms within 14 days of such change .
Advantages of registration :
Advantages to the firm : The firm gets a right to the third parties in civil suits for getting its rights enforced . In the absence of registration, the company can not sue external partners.
Advantages to creditors : A creditor can sue any partner for recovering his money due from the firm . All partners whose names appear on the registry are personally responsible for outsiders. Therefore, creditors can recover their money from any partner of the company.
Advantages to partners : The partners can approach a court of law against each other in case of dispute among partners . The partners can also sue external parties to recover their amounts, etc.
Advantages to incoming partners : A new partner can fight for their rights in the company if the company is registered. If the company is not registered, it will have to depend on the honesty of the other partners.
Advantages of outgoing partners : The registration of a firm benefits the outgoing partners in a number of ways . The outgoing partners may be divided into two categories : On the death of a partner , on the retirement of a partner. On the death of a partner his successors are not responsible for the liabilities incurred by the firm after the date of his death .
In case of a retiring partner , he continues to be responsible up to the time he does not give public notice . The public notice is not registered with the registrar and he ceases his liabilities from the date of this notice. So, it is essential to get a firm registered for getting these advantages .
Effects of Non-Registration of firms :
- The Indian Partnership Act of 1932 neither makes the registration of a firm compulsory nor imposes any penalty for non-registration .However , an unregistered firm suffers from certain disabilities . They are :
- An unregistered firm cannot file a suit in a court of law against the third parties for the recovery of its debts exceeding Rs.100 .
- An unregistered firm cannot file a suit against any of its partners for the recovery of its debts .
- A partner of an unregistered firm cannot file a suit in a court of law against the third parties or against the firm or against his co-partners for the recovery of the claims .
- Rights and Duties of partners :
- Rights of partners :
- Right to have access to accounts and books .
- Right to interest on capital .
- Right to take part in the conduct of the business of the firm .
- Right to be consulted .
- Right of indemnity .
- Right to the partnership property .
- Right to share profits of the firm .
- Right to interest on advances .
- Power or authority in an emergency .
- Right to have the partnership property used exclusively for the firm .
- Right to act as agent of the firm .
- Right to prevent the introduction of a new partner .
- Right to retire .
- Right to carry on competing business .
- Not liable for acts done before his joining the firm .
- Right to share the profits after retirement .
- Right to continue in the business of the firm .
- Duties of partners :
- Duties to render true accounts to his partners .
- Duty to carry on the business of the firm to the greatest common advantage .
- Duty to be faithful to his co-partners .
- Duty to indemnify for fraud .
- Duty to give full information .
- Not to claim remuneration .
- Not to assign his rights and interest in the firm .
- Duty to attend diligently to his duties .
- To use the firm’s property exclusively for the firm .
- To share losses equally .
- To indemnify for wilful neglect .
- To account for any personal and secret profits derived by him from the firm .
- To act within his authority .
- Not to compete with the business of the firm .
Dissolution of partnership :
In the case of dissolution of partnership , only one or some of the partners terminate their connections with the firm .It may or may not bring the business of the firm to an end . In the case of dissolution of partnership , as the business of the firm is not brought to an end , it can be continued by the remaining partners . Dissolution of partnership need not necessarily result in dissolution of firm . The scope of dissolution of firm is wide .
Circumstances leading to dissolution of partnership :
- On the expiry of the fixed term , if the partnership is formed for a fixed term .
- On the completion of particular venture or ventures , if the partnership is formed for a particular venture or ventures .
- On the death of any partner or partners .
- On the insolvency of any partner or partners .
- On the retirement of any partner or partners .
Dissolution of firm :
In case of dissolution of a firm , all the partners terminate their connections with the firm . It does bring the business of the firm to an end . As the business of the firm is brought to an end , there is no question of continuance of the businesses of the firm . It necessarily results in dissolution of partnership . The scope of dissolution of partnership is not wide .
Circumstances leading to dissolution of a firm :
- A firm formed for a fixed period is automatically dissolved on the expiry of the fixed period , if there is no agreement among the partners to continue the firm.
- A firm formed for a particular venture or ventures is automatically dissolved on the completion of the particular venture or ventures , if there is no agreement among the partners to continue the firm .
- A firm is automatically dissolved on the death of one or more partners , if there is no agreement among the remaining partners to continue the firm .
- A firm is automatically dissolved on the insolvency of one or more partners , if there is no agreement among the remaining partners to continue the firm .
- A firm is automatically dissolved on the retirement of one or more partners , if there is no agreement among the partners to continue the firm .
- A firm is compulsorily dissolved on the death of all the partners or all the partners except one .
- A firm is compulsorily dissolved on the insolvency of all the partners or all the partners except one .
- A firm is compulsorily dissolved on the retirement of all the partners or all the partners except one .
- A firm is compulsorily dissolved when its business becomes illegal on the happening of any subsequent event .
- A firm is compulsorily dissolved with the consent of all the partners or in accordance with an agreement among all the partners .
- A partnership-at-will is dissolved by any partner giving 14 days notice to all the other partners of his intension to dissolve the firm .
- A firm is dissolved by an order of the court . The court issues an order for dissolution , when a suit is brought by a partner for dissolution . A partner can bring a suit for dissolution on any one of the following grounds :
- When a partner became insane .
- When a partner has become permanently incapable of performing his duties as a partner .
- When a partner is guilty of misconduct affecting the business of the firm .
- When a partner persistently disregards the partnership agreement .
- When a partner has transferred his share in the firm to a third party without the consent of all the partners .
- When the business of the company cannot be carried on except at a loss .
- When the court is satisfied to dissolve the firm in the interest with the partners .
Settlement of accounts on dissolution :
The assets of the firm , including the income and expenditure from capital , should be used in the following order :
- First , for paying the liabilities of the firm ;
- Secondly , for paying off the loans from the partners ;
- Thirdly , for paying off the partners capitals ;
- Lastly , if there is any surplus after paying off the partners capitals , it is distributed among all the partners in their profit sharing ratio .
Advantages of partnership :
Easy to form : This is a suitable type of organisation requiring no legal formalities . No formal documents are required to be prepared as is necessary in case of joint stock company . A single agreement among partners is sufficient to start partnership firm . A partnership deed is not necessary though it is advisable to prepare it . Even the registration of firm is optional .
Large resources : The resources of more than one person are available for the business . The partners can contribute to start a moderately large-scale concern . More partners can be added if capital needs are large . The partnership concern can also arrange funds from the outside sources .
Greater managerial talent : The partners may be assigned duties according to their talent . Different functional departments may be managed and controlled by different partners . The talent , expertise and knowledge of partners is different fields can be used for the welfare of the business . It will help to increase the efficiency of the business resulting in more profits .
More credit-standing : The partners may have sufficient contacts in the market. They can offer more securities to the financial institutions . The liability of partners being unlimited , they will be able to raise more finances . As compared to a sole-trade business , partnership firm has more credit worthiness .
Promptness in decision making : The partners meet frequently and they can take prompt decisions . The firm will not lose any business opportunities because of delay in taking a decision .
Sharing of risk : The risk of business is shared by more persons . The burden of every partner will be much less as compared to the burden of sole-trade . Furthermore, the business expansion will not be hampered for fear of risk .
Relationship between reward and work : The partners try to put more labour to earn more and more profits . There is a direct relationship between reward and work . The more they work , the more they be benefited .
More possibility of growth and expansion : As compared to a sole-trade business , partnership concerns has more possibilities for expansion and growth of business activities . The partner can contribute more and manage the activities more and systematically .
Close supervision : The partners themselves look after the business ; so they can avoid wastages . They have direct access to the employees and can encourage them for more production . The management of partnership is much cheaper as compared to a joint stock company where experts are paid higher salaries .
Flexibility of operations : There is no statutory obligations to seek approval from government before making major changes in the business set up . There can be any change in managerial set-up , capital and scale of operations . These changes can be made easily depending upon the business opportunities .
Secrecy : A partnership concern is not expected to publish its profits and loss account and balance sheet as it necessary for a joint stock company . The partners can keep the business secrets to themselves . The competitors don’t know about the exact position of the business . The secrets of business are very important for a small concern .
Protection of minority interest : Every partner has a right to participate in the management of the business . All important decisions are taken by the consent of all partners . If a majority decision is enforced on minority then effected partners can get the business dissolved .
Easy dissolution : The partnership can be dissolved on insolvency , lunacy or death of a partner . If the partnership is at will , then any partner can get the firm dissolved by giving notice to other partners . No legal formalities are required at the time of dissolution . So it is easy to start as well as dissolve a partnership concern .
Democratic administration : All partners may take active interest in the working of the firm . All the partners are consulted on important decisions . Generally , strategic decisions are taken by concensus only .
Saving in managerial expenses : There are savings in expenses of a partnership firm . The partners divide all important functions among themselves and look after them . In other forms like joint stock company managerial expenses are huge because they have to depend on hired employees .
Disadvantages of partnership :
Unlimited liability : The liability of partners is unlimited . They are not only liable for their business investments but their private properties can also be taken for business liabilities . Partners try to avoid risks and it restricts the expansion and growth of the business .
Limited resources : There is limitation in raising additional resources for expansion purposes . The business resources are limited to the personal funds of the partners . Borrowing capacity of the partners is also limited . The number of partners to be added to a business is also limited . A banking company cannot have more than ten partners and in other business the number of partners cannot exceed twenty . So , there is a limit beyond which partners cannot be added .
Instability : The partnership concern suffers from the uncertainty of duration because it can be dissolved at the time of death , lunacy or insolvency of a partner . The lack of trust among the partners can also lead to dissolution . The discontinuity of the business is a social loss and it causes inconvenience to the consumers and workers .
Mutual distrust : The mutual distrust among the partners is the main cause for the dissolution of partnership concerns . It is difficult to maintain harmony among the partners because they may have different opinions and may not agree on certain matters . Lack of confidence in each other can be a cause for quarrels and it may lead to the dissolution of the firm .
Limitations on transfer of share : No partner can transfer his share to a third party without the consent of the other partners . If a partner wants his share back it will not be possible without the approval of other partners or without dissolution of the firm . In case of a company , any shareholder can transfer his shares without affecting the working of the business . In partnership , a partner is permanently wedded to it .
Burden of implied authority : A partner can bind the business by his acts . He can act as an agent of the business . A dishonest partner may lead the business in difficulties . The other partners will have to meet the obligations incurred by the partner . The provision of implied authority may create problems for the business .
Lack of public faith : The accounts of partnership concerns are not published . So , public is unaware of the exact position of the business . There is a suspicion in public mind that these concerns earn huge profits at the cost of consumers . There is no legal binding for the publication of accounts . So , partnership concerns lack public confidence .
Lack of prompt decisions : all important decisions are taken by the consent of partners so decision-making process becomes time consuming . There may be a possibility of losing business opportunities because of slow decision-making . The decisions are generally taken by condenses , it may be difficult to convince all the partners for agreeing to a particular decision .
Cautious approach : Unlimited liability of partners leads to cautious approach on the part of partners . They try to avoid decisions where some sort of risk is involved. A number of business opportunities may be lost due to this type of tendency . Moreover, risk bearing capacity of partners may also be limited .
Suitability or applicability of partnership to a particular business :
- It is suitable where the size of the business is moderate , and the capital requirements are moderate .
- It is suitable where diversified managerial talents are required .
- It is suitable for professional services like accounting professional , medical profession , legal profession , etc .
- It is suitable for service enterprises like transport , finance , etc .
- It is suitable for stock broking .
- It is suitable for distribution agencies .
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