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Dissolution by notice of partnership at will

Section 43 of The Indian Partnership Act,1932: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.

Section 17 (b) of the act provide that if a firm, constituted for a fixed term continues to carry on business after the expiry of the term, then the partnership will become partnership at will and mutual rights and duties of partners will remain same as they were before the expiry.

Rights and Responsibilities of PartnersThe Partnership Act define the basic rights and responsibilities of partners. Some of these can be changed by the partnership agreement, except, as a general rule, those laws that govern the partners’ relationships with third parties. In the absence of a written agreement, then, the following rights and responsibilities apply:

 

Rights

  • All partners have an equal share in the profits of the partnership and are equally responsible for its losses.
  • Any partner who makes a payment for the partnership beyond its capital, or makes a loan to the partnership, is entitled to receive interest on that money.
  • All partners have equal property rights for property held in the partnership’s name. This means that the use of the property is equally available to all partners for the purpose of the partnership’s business.
  • All partners have an equal interest in the partnership, or share of its profits and assets.
  • All partners have an equal right in the management and conduct of the business.
  • All partners have a right to access the books and records of the partnership’s accounts and activities at all times. (This does not apply to limited partners.)
  • No partner may be added without the consent of all other partners.

Responsibilities

  • Partners must report and turn over to the partnership any income they have derived from use of the partnership’s property.
  • Partners are not allowed to conduct business that competes with the partnership.
  • Each partner is responsible for contributing his or her full time and energy to the success of the partnership.
  • Any property that a partner acquires with the intention of it being the partnership’s property must be turned over to the partnership.
  • Any disputes shall be decided by a majority vote.

Dissolution of partnership and dissolution of firm

Dissolution of partnership is only reconstruction of firm while dissolution of firm means no more from exists after dissolution.

What happens after a dissolution notice is served?

Unless there is an express agreement between partners permitting retirement, no partner can retire from a partnership at will.  The only way to bring about termination of the relationship is for one or more of the partners to give notice of dissolution to the other(s).

However, on notice of dissolution being given, a firm may not immediately cease to trade.  Indeed, a firm may carry on trading for a considerable period.  This is driven by two factors, firstly the duty to clients/customers to complete retainers/contracts, and secondly the benefit if any of continuing the dissolved firm as a going concern until it can be sold (possibly to one or more of its partners, or otherwise to an outside purchaser) or merged into another firm, or otherwise dealt with so as maximize the benefit to partners and/or minimize the potential downsides.

Whether or not the firm continues to trade, until the winding up of the firm is complete (and this can take many years, even if the firm does not continue to trade) the partners at the date of the dissolution notice (including the partner(s) who served it), remain as partners, with a continuing duty of good faith to one another, and a continuing ability to bind one another to contracts with third parties for the purpose of the winding up.

The principal downsides of dissolution are normally as follows:

The partners’ income tax is normally accelerated by a year, subject to any overlap relief to which individual partners may be entitled.

Redundancy/lieu of notice payments may become payable to staff.

Liabilities may arise from leases that cannot be assigned or can only be sub-let at an under-rent.

Ongoing storage of files and papers (not underpinned by ongoing income).

Costs of recovery of unpaid fees, or loss of unpaid fees, particularly where clients decide to try to avoid payment in the hope that a firm that ceases to trade may not bother to/be in a position to sue for fees and/or based on alleged breach of retainer arising out of cessation of services/inadequate service following the dissolution.

In the case of a firm of solicitors, if there is no successor firm for insurance purposes (e.g. a firm with which the dissolved firm merges) then the dissolved firm must purchase (six years’) run-off insurance, typically at a premium of between two and three times last annual premium.

For so long as the firm continues to trade these downsides may not materialize, and can be avoided altogether at any stage if all of the partners agree to an (often back-dated) retirement of the partner who served the notice, or other form of acquisition by the “continuing” partners, thus bringing about a technical dissolution only, which does not lead to the downsides listed above.

In the absence of any such agreement the firm will be in what is known as general dissolution, and will have to be wound up, and the downsides listed above will occur.

As partners make plans to go elsewhere and/or as they physically leave the firm, the income of the firm may well diminish and/or partners may not account fully or at all for accrued WIP (preferring, dishonestly, to bill it in their new firm, where they may be able to retain 100% of its value for themselves).  At the same time the outgoings (e.g. rent) may not diminish at the same rate or at all, and eventually a marginal position may come about in which it is not economic to keep the firm going, even in order to complete long retainers (for example to complete litigation) with the result that bills cannot be rendered and/or claims for repayment of fees or damages may be made by clients.

Along the way, partners will be looking for a safe haven in another business, and will wish to take clients with them in order to secure the best terms for themselves in their new business.  Disputes may well arise between the partners in relation to who should take which clients with them (none or them being entitled to do so as of right, at least until the firm could no longer carry out the work and there is no prospect of anyone paying for the goodwill).

In the absence of an event such as a merger which prevents a general dissolution, other businesses may be put off recruiting partners of the dissolved business (and this potentially includes the partner who served the notice).  Such businesses may fear that those partners may be saddled with personal liabilities arising out of the dissolution.

In the case of solicitors, other firms may be wary of taking on partners in such a way as to make the acquiring firm a successor practice to the old firm for insurance purposes.  This can arise in many different ways and if it does arise the acquiring firm will be required to take out insurance at next renewal which takes into account the claims history of the dissolved firm, thus substantially increasing the premium.

Matters such as this tend to encourage settlement between the partners of the dissolved firm, in the form of an agreed retirement of the leaving partner.  In the event of such a settlement, it is important to document it properly.  There are many traps for the unwary.

Generally the only reason a group of partners will elect to wind up the firm, rather than agree to the retirement of the partner who wants to leave, is where the extent of the assets and/or continuing/anticipated future work are so outweighed by the actual or future liabilities that the partners do not want to release the leaving partner from his obligation to contribute to those liabilities and/or to release the leaving partner’s capital.  In such circumstances they will insist on the leaving partner remaining as a partner in the dissolved firm (as he does automatically unless released by agreed retirement), sharing all of the liabilities.

In essence, when a partner gives notice of dissolution, his co-partners will need to consider what (if any) amount (in addition to the return of the “leaving” partner’s capital) they are prepared to pay for the benefit of the firm’s fixed assets, name and goodwill, whilst also taking on the liabilities of the firm.  The balance sheet in the accounts will not provide the answer.  The biggest elements taken into account in any settlement tend to be the value of goodwill (which is usually not reflected in the balance sheet), off-balance sheet work-in-progress, and sometimes off-balance sheet liabilities (often associated with leases), all of which can be difficult to value.

Effect of non-registration: Section 69 reads out:

(1) No suit to enforce a right arising from a contract or conferred by this Act shall be instituted in any Court by or on a behalf of any persons suing as a partner in a firm against the firm or any person alleged to be or to have been a partner in the firm unless the firm is registered and the person suing is or has been shown in the Register of Firms as a partner in the firm.


(2) No suit to enforce a right, arising from a contract, shall be instituted in any Court by or on behalf of a firm against any third party unless the firm is registered and the persons suing are or have been shown in the Register of Firms as partners in the firm.

(3) The provisions of sub-sections (1) and (2) shall apply also to a claim of a set-off or other proceedings to enforce a right arising from a Contract, but shall not affect—
(a) the enforcement of any right to sue for the dissolution of a firm or for accounts of a dissolved firm, or any right or power to realize the property of a dissolved firm, or
(b) the powers of an official assignee, receiver or Court under the Presidency-towns Insolvency Act, 1909 (3 of 1909) or the Provincial Insolvency Act, 1920 (5 of 1920) to realize the property of an insolvent partner.

(4) This section shall not apply—

(a) to firms or partners in firm which have no place of business in the territories to which this Act extends, or whose places of business in [the said territories], are situated in areas to which, by notification under [Section 56], this Chapter does not apply, or
(b) to any suit or claim of set-off not exceeding one hundred rupees in value which, in the Presidency-towns, is not of a kind specified in section 19 of the Presidency Small Cause Courts Act, 1882 (5 of 1882), or outside the Presidency-towns, is not of a kind specified in the Second Schedule to the Provincial Small Cause Courts Act, 1887 (9 of 1887), or to any proceeding in execution or other proceeding incidental to or arising from any such suit or claim.

Explanation of the Section in a nut-shell:

The Section is divided into for sub-sections.

(a) The enforcement of any right to sue for the dissolution of a firm or for accounts of a dissolved firm.
(b) The powers of an official assignee, receiver or Court under the two Insolvency Acts for realization of the property of an insolvent partner.

Sub-section (4) mentions firm and certain types of suits and claims of set off to which sub-sections (1) and (2) are not made applicable. A ‘claim of set-off means that if an unregistered firm is sued by a third party to recover a sum of money, the firm cannot say that the money owing by that third party to the firm should be set off against the claim. The words ‘other proceedings’ now include arbitration proceedings.

Under the Indian Partnership Act, 1932, registration of a firm is optional and not mandatory. The Section lays down the effect of non-registration of a firm which enforces a right arising from a contract by a partner against other partners or by or on behalf of a firm against any third party and provides that such a suit shall not be entertained unless the firm is registered and the person suing is or has been shown in the Register of firms as a partner.
However, there are certain exceptions in the Section, these are:

1) Dissolution and accounts. — An unregistered firm can bring an action for the dissolution of the firm or for accounts of a dissolved firm. They can also enforce any right or power to realize the property of a dissolved firm. With the dissolution of the firm, the disability to sue also disappears. Also, suit for damages for misconduct can be brought by one partner against another even if the firm is unregistered. This enforces the claim of a firm for realization of its assets.

2)  Insolvent’s share — The official assignee, receiver or Court acting for an insolvent  partner may bring an action for realization of the insolvent’s share irrespective of the fact that the firm is an unregistered one.

3)  Suit of Rs. 100. — An unregistered firm and its partners may sue or claim a set-off where the suit does not exceed rupees hundred in value.
4)  Statutory and non-contractual rights. — These are outside the scope of Section 69 of Indian Partnership Act, 1932. For example, an unregistered firm is allowed to sue for a permanent injunction to prevent passing off or infringement of its trade mark. Statutory tenancy rights are enforceable against unregistered firms which hold tenancy.

5)  Third parties. — They can always sue unregistered firms.
Clash has arisen as to whether arbitration proceedings fall within the ambit of Section 69 (3) of

The dispute over Section 69 (3):

A number of High Courts had taken different views. The Bombay, Calcutta and Patna High Court held that the words ‘other proceedings’ have to be interpreted in a manner  so that arbitration proceedings are not barred by the Section.

Sub-section (1) prevents a person from suing as a partner in a firm, either the firm or a person who is alleged to be a partner in the firm, in respect of any right arising out of a contract of partnership or any other rights conferred by the (Partnership) Act, unless the firm is registered.

Sub-section (2) prevents a similar suit against a third party in respect of any contract by the firm unless it is registered and it is shown that the persons suing on behalf of the firm are partners in the firm.

Sub-section (3) provides that sub-sections (1) and (2) would also apply to a claim of set-off or other proceeding to enforce a right arising out of a contract, but it proceeds to carve out exceptions by clauses (a) and (b) in two cases :

 

Under Section 69(2) of the Partnership Act, registration of firm for instituting a suit in the name of firm in question is mandatory.

Non-registration of a partnership does not abrogate the contract of partnership; it merely affects the right of partnership firm to sue the third parties for recovery of amounts due from them to the partnership.

The registration of a firm is a condition precedent to its right to institute a suit and a Court cannot proceed with a trial of a suit when the condition precedent has not been fulfilled.

An unregistered firm cannot file such a suit. A suit by an unregistered firm cannot be validated by the subsequent registration of the firm. This disability is a great compelling force to bring the firm to register. This disability is in the nature of a penalty though there is no provision of penalty for non-registration.

 

Indian Partnership Act, 1932, or not?

The Allahabad High Court had taken the contradictory view and held that ‘other proceedings’ has to be interpreted independently and is not to be read in the light of preceding ‘set-off’ and an application under Section 20 of the Indian Arbitration Act, 1940, would be within the purview of the term ‘other proceeding’.

It was further held that it was not the intention of the Legislature to restrict the operation of sub-section (3) of Section 69 only to set -off or other similar claim to be made in a written statement. So, an application under Section 20 of the Arbitration Act, 1940, to enforce ‘a right arising from a Contract’ in respect of an unregistered firm is barred by the provisions of Section 69 (3) (a) and (b) of the Indian Partnership Act, 1932.


All of them agreed that if a suit falls within the category of clause (a) or (b) of Section 69, then, sub-section (1), (2) and (3) of Section 69 will not be applicable. Therefore, a suit under Section 20 of the Indian Arbitration Act, 1940, if it falls within the scope of clause (a) or (b) of Section 69, then the suit would not be barred by sub-section (1), (2) and (3) of Section 69.


CASE
:In Jagdish Chandra Gupta v. Kajaria Traders (India) Ltd.,
an application was moved under Section 8 of the Arbitration Act, 1940, to get an arbitrator appointed for settling the disputes between the parties. It was contended that Section 69 (3) of the Indian Partnership Act, 1932, barred the petition as it was an unregistered firm. The Hon’ble Court held that the application under Section 8 of the Arbitration Act, 1940, was covered by the expression ‘other proceeding’ in Section 69 (3) of the Indian Partnership Act. It was further held that the proceedings were to enforce a right arising from the contract of the parties, therefore, if the proceedings under Section 8 of the Arbitration Act, fall under Section 69 (3) of Partnership Act, there is no reason as to why the proceedings under Section 20 of the Arbitration Act should not be sheltered under Section 69 (3) of the Indian Partnership Act.

Section 44: Dissolution by court

Assets and Liabilities on Dissolution

CASE: In C.I.T vs. Pigot Chapman & Co., AIR 1982 SC 1085

in the instant case, therefore, the question is whether there has been dissolution of the old firm followed by the creation of a new firm which could be said to have succeeded to the business of the old firm. The summarized facts are as follows, the effect of the earlier documents commencing from the initial deed of partnership dated 18th May, 1953 right up to the Deed dated 30th of March, 1959 with which we are principally concerned. On an examination of these documents the following facts emerge clearly:
(a) that the initial partnership between Haywood, Blomenstok, Ablitt and Roy under the deed dated 18th May, 1953 was for a fixed term of six years from 1-4-1953 and as such the same would automatically stand dissolved under Section 42(a) of the Partnership Act on 31-3-1959;

(b) under the deed dated 30th of March, 1959 the partnership between Mclean, Ablitt and Roy Was in terms “dissolved by mutual consent as from 1st April, 1959;”

(c) the document expressly states both in the recital portion and in the operative part (vide Clauses 1 and 2) that the firm has been dissolved by mutual consent;

(d) the continuing partners were given the sole right to collect all the assets of the dissolved firm and to issue, recover and give full receipts for all debts of that firm;

(e) each of the parties to the deed released the other from all proceedings, accounts, costs, claims and demands in respect of the dissolved firm;

(f) the Tribunal found as a fact that the relevant account books clearly indicated that the old firm stood dissolved and its assets and liabilities were taken over by the new firm of the two continuing partners and

(g) within three months another document was executed on 29th June, 1959 by and between the continuing partners recording the terms and conditions on which the continuing partners, to the exclusion of the retiring partner, were to carry on the business of the old firm with effect from 1-4-1959. Having regard to these facts and circumstances which emerge clearly on record it seems to us that both the Tribunal as well as the High Court were right in coming to the conclusion that the old firm was dissolved on 1st April, 1959 and it was the case of a new firm succeeding to the old business and therefore, the respondent assessee was entitled to the relief claimed under Section 25(4) of the 1922 Act in respect of its income for the Assessment Year, 1959-60.


Sale of Goodwill after dissolution

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.

Where the goodwill of a firm is sold after dissolution, a partner may carry on business competing with that of the buyer and he may advertise such business, but, subject to agreement between him and the buyer., he may not,-
(a) use the firm name,
(b) present himself as carrying on the business of the firm, or
(c) solicit the custom of persons who were dealing with the firm before its dissolution.

Rights and Duties of Partners: at the time of sale of goodwill

At the time of dissolution all partners have the right to sell the goodwill of the firm for the common benefit of the partners. This does not restrict the right merely to general dissolution. The legal representatives of the deceased partner are also entitled to a share in the goodwill of the partnership which is continued after the death of the partner.

Goodwill is essentially estimation by the customers and protecting goodwill means protecting the custom of the firm. The seller may continue to trade in the same field, can offer competition in every lawful manner, advertise to the general public and follow other commercial tactics. He may offer better and cheaper services, if he can so afford, and divert the flow of customers to his new place, but not, by a personalized approach or solicitation. This is necessary to ensure freedom of trade to every individual.

However if the seller of the goodwill represents to the customer that he is the same person carrying on the old business, it would destroy the buyer’s purchase of goodwill. Therefore certain restrictions are required to be imposed on the seller and buyer of goodwill. This section essentially speaks of such restrictions and the boundary within which both parties have to function. Though restrictions are to be imposed, it must also be noted that common law normally does not provide for restrictions on trade. Therefore a level of balance has to be maintained.

Sub section 2 of Section 55 provides that though the seller may continue the business as he pleases, he may however not,

# Use the firm name,
#Cannot represent to the people that he is carrying on the old business.
# He cannot solicit the custom of persons who were dealing with the firm before its dissolution.
# He cannot approach customers with the intention of diverting them to his business, but ’is at liberty to deal with them if they come to him of their own accord’.
Even the representatives of a deceased partner cannot do such solicitation.

Mode of settlement of accounts between partners

In settling the accounts of a firm after dissolution, the following rules shall, subject to agreement

By the partners, be observed-

(1.) losses, including deficiencies of capital, shall be paid first out of profits, next out of capital, and, lastly, if necessary, by the partners individually in the proportions in which they were entitled to share profits;

(2.) The assets of the firm, including any sums contributed by the partners to make up deficiencies of capital, shall be applied in the following manner and order-

in paying the debts of the firm to third parties;

in paying to each partner rate ably what is due to him from the firm for advances as distinguished from capital;

in paying to each partner rate ably what is due to him on account of capital; and

The residue, if any, shall be divided among the partners in the proportions in which they were entitled to share profits.

Refund of Capital Contributed

Section 48 provides for the refund of the actual capital contributed and if the available assets are insufficient to refund the said amount,a rateably reduced amount shall have to be refunded. The term ‘capital’ referred here, has the same meaning as elsewhere in the act; it can not be equated to the term “assets” of the firm at all.

Capital Contributed by a partner is in the nature of the advance or a loan advanced to the firm by a partner; it has no higher quality at all. Just as the loan advanced by the partner does not get expanded in proportion to the enhanced value of the assets the capital contributed by a partner also does not get augmented in proportion to the assets of the firm.

The distribution of surplus is for the purpose of adjustment of the rights of the partners in the assets of the partnership, it does not amount to transfer of assets.

Section 47 of IPA, 1932: Rights of Partners to have business wound up after dissolution

On the dissolution of a firm every partner or his representative is entitled, as against all other partners or their representatives, to have the property of the firm applied in payment of the debts and liabilities of the firm and to have the surplus distributed among the partners or their representatives according to their rights.

Continuing authority of partners for the purposes of winding up

After the dissolution of a firm the authority of each partner to bind the firm and the other mutual rights and obligations of the partners continue notwithstanding the dissolution, so far as may be necessary to wind up the affair of the firm and to complete transactions begun but unfinished at the time of the dissolution, but not otherwise.

Provided that the firm In no case bound by the acts of a partner who has been adjudicated insolvent; but this proviso does not affect the liability of any person who has after the adjudication represented himself or knowingly permitted himself to be represented as a partner of the insolvent.

Value of share of outgoing partner

1. As stated in CASE:Chillakam Chandrshkekhar Reddy v.Pamuru Vishnu Vinodh Reddy,AIR 1995 AP 49
Section 37 of the Indian Partnership Act, also says that in the case of an outgoing partner, he is entitled to such share of the profits made since he ceased to be a partner as may be attributable to the use of his share of the property of the firm or to rate of interest per annum on the amount of his share in the property of the firm. 37 of IPA, 1932 is that “since he ceased to be a partner”. In other words, since he ceased to be a partner, he is entitled to interest per annum on the amount of his share in the property of the firm. 37 itself makes it clear that the relevant date is the date on which he ceases to be a partner. The proviso to Section 37also says that if option is given to surviving partners to purchase the share of an outgoing partner and if any partners assuming to act in exercise of the option does not in all material respects comply with the terms thereof he is liable to account under Section 37.

2. The language used in Section

3. Section

Payments of firm debts and separate debts1.Incase of firm debts the property of the firm shall be applied in the first instance in payment of the debts of the firm.

 

2. The separate property of any partner shall be applied first in the payment of his separate debts, and the surplus (if any) in the payment of the debts of the firm.


Section 16 (a) & (b) and Section 50 of The Indian Partnership Act,1932: Personal profits earned after dissolution

1. If a partner derives any profit for himself from any transaction of the firm, or from the use of the property or business connection of the firm or the firm name, he shall account for that profit and pay it to the firm.

2. If a partner carries on any business of the same nature as and competing with that of the firm ,he shall account for and pay to the firm all profits made by him in that business.

3. The above sections shall apply to the transactions by any surviving partner or by the representatives of a deceased partner, undertaken after the firm is dissolved on account of the death of a partner and before its affairs have been completely wound up.

4. Provided that where any partner or his representative has brought the goodwill of the firm, nothing in this section shall affect has right to use the firm name.

Section 51 of The Indian Partnership Act, 1932: Return of premium on premature dissolution

1. If the partner has paid a premium on entering into partnership of a fixed term, and the firm is dissolved before the expiration of that term otherwise than by the death of a partner, he shall be entitled to repayment of the premium or of such part thereof as may be reasonable, regard being had to the terms upon which he became a partner and to the length of time during which he was partner.

2. Unless the dissolution is mainly because of his own misconduct or in pursuance of an agreement containing no provision for the return of the premium or any part of it.

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