Introduction
A partnership is a form of business operation that involves two or more people. The profits and liabilities of the business are shared among the partners. As per their legal contract, they contribute to the daily operations of the business while earning a salary.
What is Partnership?
Any cooperative effort started by multiple parties can be considered a partnership. Governments, corporations, non-profits, or individuals can act as parties to the deal. Individuals can set up three different kinds of partnerships. These include-
General Partnership
Limited Partnership
Limited liability Partnership
In the event that business partners decide to dissolve their partnership, they will suspend all operations in their venture and liquidate their assets.
Dissolution of Partnership
A partnership is a type of business in which two or more people come together in a formal agreement and agree to be the owners, share responsibilities for running an organization, and agree to share the profits and losses of that organization.
A partnership in India is governed by the Indian Partnership Act 1932, which oversees all aspects and functions of the partnership. As defined by this law, a partnership is an association between two or more individuals or parties who have agreed to split the profits generated by the business. The profits generated from the business are shared among all the partners or their representatives.
All rights and responsibilities delineated in this agreement pertain to each business partner. Partner agreements identify the names of both parties, the purpose for which the partnership was formed, the location of the business, the amount that each partner invested, and the proportion of profits that each partner received.
According to the Partnership Act of 1932, this partnership can be dissolved only in cases where certain predefined conditions are met, such as:
Dissolution by Agreement
Dissolution by Notice
Dissolution by the Court
Compulsory Dissolution
Conditional Dissolution
Difference of Dissolution of Partnership and Dissolution of Partnership Firm
A Dissolution of a partnership is different from the dissolution of a partnership firm. Partnerships are dissolved when business relations change between partners, while firms are dissolved when the relationship between partners and the firm is dissolved. Consequently, all assets and liabilities are disposed of in the appropriate way in this case.
In the context of a partnership, a dissolution can be thought of as when one of the partners ceases to be part of the business. This cannot be combined with a termination of the partnership. It is possible to define dissolution as the process of ending a partnership. Dissolving the partnership does not mean that the remaining partners are no longer partners, but that they are a completely different partnership.
How Does a Partnership Dissolve?
Partner participation in a business operation generally ends or dissolves a partnership. There are three ways to dissolve a partnership.
In an Act of Partnership- When one or more partners agree to dissolve the partnership at a certain time. Partnerships can be agreed upon to last for a period of five years, for example. At the end of the five-year period, the agreement can be dissolved by the partners. Occasionally, it may be mentioned that certain conditions apply to the suspension of a partner. It is possible for the partnership to dissolve if one of the partners breaks a rule.
Through the Operation of Law- Partnerships are governed by law and are the result of an agreement. Thus, the partnership contract can be canceled if there are any hindrances to the contract or unlawful actions. As an example, selling illegal items cannot be part of a legal partnership.
By Court Order- The law will only allow a partnership to dissolve when there is no partner working, a partner breaching an agreement, a partner who is mentally unstable and the partner has misbehaved in a manner that impacts the partnership.
Dissolution Statement- The statement needs to be filed with the secretary of state. Access to the form is available on the secretary of state's website. Name, date, and dissolution reason must all be included on the form.
Individual Notification- Individual creditors of the partnership will need to receive notice in writing. Publicize the partnership announcement in a newspaper and inform all parties involved in the partnership.
The Dissolution Can Occur for Various Reasons. Some of the Primary Reasons are:
In case any changes are to be made in the current profit sharing ratio among partners.
If a partner retires or expires
When a new partner joins the business
In case a partner goes bankrupt
If a partnership was formed for a particular objective or goal and it has been fulfilled.
In case a partnership was established for a specific time, then after that period it can be dissolved
What is a Partnership Dissolution Deed?
A deed for partnership dissolution is the legal document that allows dissolving a partnership. This deed is available in various formats depending on the condition of this dissolution.
Dissolution of partnership is a broad topic as it comprises several different factors. This article is a brief insight into the matter and covers every aspect of it. If you want to learn more on this topic, visit the official website of Vedantu.
FAQs on Partnership Dissolution: Processes Explained
1. What are the different modes for the dissolution of a partnership firm as per the Indian Partnership Act, 1932?
According to the Indian Partnership Act, 1932, a partnership firm can be dissolved in several ways:
- Dissolution by Agreement: When all partners mutually agree to dissolve the firm.
- Compulsory Dissolution: When the business of the firm becomes illegal or when all partners (or all but one) become insolvent.
- On the Happening of Certain Contingencies: If the firm was constituted for a fixed term, on the expiry of that term; if constituted for a specific venture, on its completion; on the death of a partner; or on a partner being declared insolvent.
- Dissolution by Notice: In a 'partnership at will', any partner can dissolve the firm by giving a written notice to all other partners.
- Dissolution by the Court: The court can order dissolution on grounds like a partner's insanity, permanent incapacity, or misconduct affecting the business.
2. What is the main difference between the 'dissolution of a partnership' and the 'dissolution of a partnership firm'?
The key difference lies in the continuation of the business. Dissolution of a partnership refers to a change in the existing agreement between partners, such as the admission, retirement, or death of a partner. The business continues, but under a new agreement (reconstitution). In contrast, dissolution of a partnership firm means the complete termination of the business. All assets are sold, liabilities are settled, and the firm ceases to exist.
3. Under what specific circumstances is the dissolution of a partnership firm considered compulsory?
The compulsory dissolution of a partnership firm is mandatory under two specific conditions as per the Indian Partnership Act, 1932:
- When the business of the firm becomes unlawful or illegal to carry on.
- When all the partners, or all partners except one, become insolvent, as they are no longer competent to contract.
In these cases, the dissolution is not optional and must be carried out immediately.
4. Why is a Realisation Account prepared during the dissolution of a partnership firm, and what does it show?
A Realisation Account is a nominal account prepared specifically during the dissolution process to determine the net profit or loss arising from the sale of the firm's assets and the settlement of its liabilities. It is prepared to close the books of the firm. All assets (except cash/bank and fictitious assets) are transferred to its debit side, while all external liabilities are transferred to its credit side. The final balance in the Realisation Account represents either a profit (if credit side is heavier) or a loss (if debit side is heavier), which is then transferred to the partners' capital accounts in their profit-sharing ratio.
5. How are the firm's assets and liabilities treated when settling accounts during dissolution?
As per Section 48 of the Indian Partnership Act, 1932, the settlement of accounts during dissolution follows a specific order:
- First, the proceeds from the sale of assets are used to pay off the firm's external liabilities (e.g., creditors, bills payable, bank loans).
- Second, any remaining amount is used to repay any loans or advances made by partners to the firm.
- Third, the balance is used to return the capital contributed by the partners.
- Finally, if any surplus remains, it is distributed among the partners in their profit-sharing ratio.
6. On what grounds can a court order the dissolution of a partnership firm?
A partner can file a suit in court to dissolve the firm on any of the following grounds:
- Insanity: When a partner becomes of unsound mind.
- Permanent Incapacity: When a partner becomes permanently incapable of performing their duties.
- Misconduct: When a partner is guilty of conduct that is likely to negatively affect the business.
- Breach of Agreement: When a partner wilfully or persistently commits a breach of the partnership agreement.
- Transfer of Interest: When a partner has transferred their entire interest in the firm to a third party.
- Perpetual Losses: When the business cannot be carried on except at a loss.
- Just and Equitable: On any other ground which the court regards as just and equitable for dissolution.
7. What is the significance of treating 'goodwill' during the dissolution of a firm?
During dissolution, goodwill is treated just like any other asset of the firm. If it appears in the balance sheet, it is first transferred to the debit side of the Realisation Account. When the goodwill is sold for cash, the Realisation Account is credited with the amount received. If a partner takes over the goodwill, their capital account is debited. Its proper treatment is crucial for accurately calculating the final profit or loss on realisation and ensuring a fair settlement among the partners.
8. What happens if a partner's capital account shows a debit balance after all adjustments during dissolution?
If a partner's capital account shows a debit balance after all adjustments for reserves, revaluation profit/loss, and realisation profit/loss, it means that the partner owes money to the firm. The partner is legally obligated to bring in cash to settle this deficiency. If the partner becomes insolvent and cannot pay their dues, the resulting loss (capital deficiency) is borne by the remaining solvent partners as per the terms of the partnership deed or, in its absence, according to the principles laid down in the famous case of Garner vs. Murray.
