How a Partnership Firm is dissolved?

How a Partnership Firm is dissolved?

1. Dissolution of Partnership Firm under Indian Partnership Act

According to the Section 39 of Indian Partnership Act 1932, the dissolution of a partnership between all the partners of a firm is called the “dissolution of the firm”. Dissolution is a process by which a partnership firm comes to an end and all its partners get free from the rights and liabilities that arose from the partnership. However, the dissolution of a partnership firm is quite different from the dissolution of partnership.

2. Difference between Dissolution of Partnership and Dissolution of Firm

Sno.Dissolution of Partnership Dissolution of Firm
1.Dissolution of Partnership refers to the end of association between a partner and the rest of the other partners.Dissolution of Firm refers to a process by which the association between all the partners end.
2.It results in the leaving of the partner who dissolved his partnership.It results in the closure of the firm.
3. Dissolution of Partnership is voluntary in nature as it is dissolved by mutual consent.Dissolution of Firm is either voluntary or compulsory in nature.
4.The rights and liabilities of only the outgoing partner dissolves.The rights and liabilities of all the partners in the firm dissolves.
5.The book of accounts of the firm continues to remain open as the business continues.The book of accounts of the firm along with the partner’s account is closed as the firm dissolves.
6.The business of the firm continues as usual.The business of the firm closes down permanently as the firm ceases to exist.

3. Different methods for Dissolution of the Firm:

Section 39 of the Indian Partnership Act, 1932 provides the firm with various methods of dissolution. A firm that is set to dissolve itself can opt for any of these methods as per the situation and requirement. 

3.1 Dissolution by Agreement

A firm can be simply dissolved if all partners of the firm give consent to the dissolution. The partners can also choose to dissolve the firm as per the method that was specified in the Partnership Deed, if any.This is the easiest method of dissolution provided by the Act under Section 40. In situations, where there is no disagreement between the partners, this method can be opted to avoid unnecessary litigation. 

3.2 Dissolution by Notice

Section 43 of the Partnership Act provides that when the partnership has been formed at will, the outgoing partner can communicate his intention to dissolve the firm by notice. A Partnership at Will is a type of partnership where no specific time period has been fixed in the Partnership Deed and thus can be dissolved as per the wishes of partners. All partnerships are considered to be at Will until it is shown that a time period was fixed.

The firm will be dissolved from the date mentioned in the notice as date of dissolution or if no date is mentioned then date of communication of notice will be considered.

3.3 Compulsory Dissolution

Section 41 of the Partnership Act provides that  a firm has has to be compulsorily dissolved in the following cases:

  1. If all partners of a firm, or all the partners except one partner, are adjudicated as insolvent.
  2. If any such event takes place which makes it unlawful for the business of the firm to be carried on or for the partners to carry it on. For example, if the firm specifically deals in production and supply of a product that the Government has decided to ban, in such case, the firm stands dissolved.

3.4 Dissolution due to the Contingencies

As per Section 42 of the Partnership Act, unless the partnership contract provides for otherwise, a firm dissolves when any of the following contingencies take place:

  1. If the partnership was formed for a fixed period, that is, the partnership was not at will, the partnership dissolves as the period is reached unless the period is renewed or extended.
  2. If the partnership was formed to carry out a particular adventure in business, it would dissolve when the operation stands completed or the objective is achieved.
  3. If a partner dies, partnership will get dissolved unless partners agree to the contrary. It means if partners decide that the partnership firm will continue even after the death of the partner then they will enter into a new agreement.
  4. If a partner is adjudicated as insolvent by any Court or Tribunal.

3.5 Dissolution by the Court

Section 44 of the Partnership Act provides that the dissolution of a firm may also be ordered by the Court if any of the following grounds are fulfilled:

  1. If a partner of the firm becomes of unsound mindi.e. incapable of intelligently taking decisions.The suit for dissolution in this case must be brought by the next friend of such partner or any partner of the firm.
  2. If a partner becomes completely incapable of performing his duties as a partner, other partners may bring the suit for dissolution.
  3. If a partner is guilty of any misconduct which could affect prejudicially the working of the firm or carrying on the business. 
  4. If a partner willfully and continuously breaches the agreement mentioned in the partnership deed or contract, or if a partner conducts in a way that is not reasonably practicable with the business.
  5. If a partner has transferred the interests he carried to a third party, against the consent of other partners.
  6. If the business of a firm cannot be carried on further without incurring losses.
  7. Or on any grounds that the court thinks of as fit.

4. The Liabilities of Partners after Dissolution 

Section 45 of the Act provides liabilities for an act of the partners after the dissolution of the firm. The partners of the firm are always liable to the third party for any act done by any of them unless they give public notice of the dissolution of the firm. This means that unless the notice of dissolution has been made public, all acts done by the partners would be deemed to have been done by the firm and therefore their joint liability continues. 

However liability would not be attached from the acts of the partner who died, or was adjudicated as insolvent or did not deal with the third party in the capacity of partner of the firm.

5. Continuing Authority for the Process of Winding Up

According to the Section 47 of the act, after the dissolution of a firm has been declared, the authority of each partner to bind the firm, and the other mutual rights and obligations of the partners will continue as may be necessary to wind up the affairs of the firm and to complete transactions begun but unfinished at the time of the dissolution.

6. Settlement of accounts of the firm

As the firm is set to dissolve, it must settle the account before the dissolution. Section 48 of the Act provides for the procedure of settlement of accounts in the following way:

  1. The losses incurred by the firm due to deficiency of capital has to be paid first out of profits of all the partners, if it stands insufficient then next from the capital and even if losses are not paid off completely then it will be settled from the personal contribution of the partners.
  2. The assets of the firm, including any sum contributed by the partners, will be applied in the following manner:
  • First to pay the debts of the firm to third parties.
  • To pay each partner proportionately to what is due to him from the firm for advances i.e loan taken by the firm from the partner other than capital.
  • To pay each partner proportionately to what is due to him from the firm in relation to the capital.
  • The surplus that is left would then be shared among the partners as per their usual sharing ratio.

DISCLAIMER: The views expressed are strictly of the author and VJM & Associates LLP. The contents of this article are solely for informational purpose. It does not constitute professional advice or recommendation of firm. Neither the author nor firm and its affiliates accepts any liabilities for any loss or damage of any kind arising out of any information in this article nor for any actions taken in reliance thereon.

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