In a partnership firm when one of the partners leaves and the rest of the partners continue the business, the partner who leaves is an outgoing partner. The partnership law dictates certain rights and liabilities for such a partner. Let’s learn more about the rights of an outgoing partner.
The Right of an Outgoing Partner to Carry on a Competing Business
Indian Partnership Act, 1932 commonly known as the Partnership law allows an outgoing partner to pursue a business that is of a competing nature with the partnership firm. The law also allows for the promotion of the business. Subsection 1 of Section 36 of the Indian Partnership Act, 1932 forces certain limiting conditions. The Act limits him from doing the following.
He cannot use the partnership firm’s name.
He cannot represent himself as a member of the partnership.
He cannot solicit the customs of people who had been dealing with the firm before he ceased to be a partner.
Subsection 2 of Section 36 of the Partnership Act mentions an agreement in restraint of trade. This subsection states that an outgoing partner may make an agreement with his partners that on ceasing to be a partner he would not carry on any business similar to that of the partnership firm within a stipulated period of time or an identified local limit. This is notwithstanding anything contained in Section 27 of the Indian Contract Act, 1872. Such agreement shall be considered valid if only the restrictions imposed are reasonable.
The Right of an Outgoing Partner to Share Subsequent Profits
Section 37 of the Indian Partnership Act, 1932 defines the right of an outgoing partner to share subsequent profits under certain circumstances. This is applicable when any member of a partnership firm dies or otherwise ceases to be a partner and the surviving or continuing partners continue with the business of the partnership firm. There is no need for any final settlement of accounts, since the outgoing partner already entitles, either by himself or by his representatives, to share his profits made by the partnership firm. Moreover, the outgoing partner or his representative is entitled to use his share of the property of the firm or draw interest at the rate of six per cent per year on the amount of his share in the property of the firm.
However, the surviving partners or the continuing partners are given an option to purchase the interest of a deceased partner or outgoing partner, and if that option gets duly exercised, the deceased partner or the outgoing partner is not entitled to any other share of profits or further share of profits in the partnership firm.
Solved Examples on Rights of Outgoing Partner
Q1: Dave, Jack and Robert are partners in a gaming company. Robert retires after he sold his share in the partnership firm. But, Dave and Jack could not pay Robert the agreed value of the share. How would Robert be able to recover the amount?
Ans: The value of Robert’s share on the date of his retirement from the partnership firm will stay as a pure debt on the partnership firm. This debt shall be applicable from the date from which Robert ceased to be a partner of the firm according to the agreement between his partners and him. His share amount could be recovered by him along with interest on the amount he was supposed to be paid.
Q2: Dave, Jack and Robert are partners in company manufacturing shoes. Dave is entitled to two-sixths of the property of the partnership firm and the profits earned by the firm. After three years of the business, Dave goes bankrupt, but Jack and Robert carry on with the business without paying out Dave’s share of the assets of the firm or settling the accounts with Dave’s estate. Would Dave get a share of the profits earned?
Ans: Yes, Dave would get his share of profits from the firm. He is ideally entitled to two-sixths of the profits of the firm from the date he went bankrupt till the final liquidation of the partnership.
Q3: Is an out-going partner allowed to continue with a business that competes with the partnership firm?
Ans: Yes, an out-going partner can continue to carry on a business which could be a competitor of the firm. He could also advertise it.
Q4: Discuss the rights and duties of an outgoing partner.
Ans: An outgoing partner enjoys his right to continue with a business which competes with the partnership firm and even advertise it. It is his duty not to use the name of the partnership firm, not to represent himself as a member of the firm. He shouldn’t take the name of the firm to introduce himself anymore, and he should avoid soliciting the custom of persons who have been dealing with the firm from before he started ceasing to be a partner.
Q5: Which Section of the Indian Partnership Act, 1932 deals with the right of an outgoing partner in certain circumstances to share future profits?
Ans: Section 37.
Q6: Section 36(1) of the Indian Partnership Act, 1932 deals with the agreement in restraint of the trade. TRUE or FALSE?
Ans: FALSE. It’s subsection 2 of Section 36 which deals with the same.
FAQs on Rights of an Outgoing Partner Explained
1. What are the primary rights of an outgoing partner under the Indian Partnership Act, 1932?
An outgoing partner, such as a retiring partner, holds several key rights to ensure a fair exit. According to the Indian Partnership Act, 1932, these primarily include:
- The right to carry on a competing business, subject to certain restrictions as defined in the partnership agreement.
- The right to share in profits earned after their exit if their accounts are not settled, as per Section 37.
- The right to have their share in the partnership property and goodwill settled and paid out.
- The right to not be liable for any acts of the firm done after their retirement, provided a proper public notice is given.
2. Who is considered an outgoing partner in a partnership firm?
An outgoing partner is a person who ceases to be a partner in a firm, while the remaining partners continue to operate the business. A partner may leave a firm in any of the following ways:
- Retirement: A partner voluntarily leaves the firm with the consent of all other partners or according to a pre-existing agreement.
- Expulsion: A partner is removed from the firm in good faith by a majority of partners, based on powers conferred by the partnership deed.
- Insolvency: A partner is declared insolvent by a court, which automatically terminates their partnership.
- Death: A partner passes away, leading to the dissolution of the partnership unless otherwise agreed upon.
3. What rights does an outgoing partner have to start a competing business, as per Section 36?
As per Section 36 of the Indian Partnership Act, 1932, an outgoing partner has the right to carry on a business that competes with the firm. However, this right comes with specific restrictions, unless an agreement states otherwise. The outgoing partner cannot:
- Use the firm's name.
- Represent themselves as still being a partner in the firm.
- Solicit the clients or customers of the firm they have just left.
4. What is the outgoing partner's right to a share in subsequent profits under Section 37?
Section 37 of the Act protects an outgoing partner when their final payment is delayed. If the continuing partners use the firm's assets without settling the amount due, the outgoing partner (or their legal heirs) has the right to choose one of two options:
- Claim a share of the profits made by the firm since their exit, which is proportionate to their share in the firm's property.
- Claim interest at a rate of 6% per annum on the amount of their unsettled share in the property of the firm.
5. How are the rights of an outgoing partner different from their liabilities?
The rights and liabilities of an outgoing partner define their complete legal and financial position upon leaving the firm. The key difference is:
- Rights are entitlements that protect the partner. These focus on what the partner is owed, such as the return of their capital, a share of accumulated profits and goodwill, and the freedom to compete in business (with some restrictions).
- Liabilities are obligations or responsibilities. The primary liability is that an outgoing partner remains responsible for all acts of the firm done before their retirement. They can also be held liable for acts done after retirement if they fail to give a public notice of their exit.
6. Under what circumstances can an outgoing partner be prevented from starting a similar business?
An outgoing partner can be prevented from starting a similar business if there is a specific agreement in the partnership deed, often called a 'restraint of trade' clause. For this agreement to be legally valid under the Indian Contract Act, 1872, it must be reasonable and clearly specify certain limits, such as:
- A defined geographical area.
- A specific period of time.
If such a clause exists and is reasonable, the outgoing partner is legally bound not to start a competing business within those specified limits.
7. Why is it crucial for an outgoing partner to give a public notice of their retirement?
Giving a public notice of retirement is crucial to terminate an outgoing partner's liability for the future actions of the firm. Without a public notice, third parties like suppliers, lenders, and customers can legally assume the partner is still part of the firm. Consequently, the outgoing partner could be held personally liable for any debts or obligations the firm incurs even after they have retired. The notice serves as an official announcement, protecting the partner from these future liabilities.
8. What happens if the continuing partners delay the settlement of the amount due to an outgoing partner?
If the continuing partners delay the final settlement, the outgoing partner must be compensated for the firm's use of their capital. According to Section 37 of the Indian Partnership Act, 1932, the outgoing partner is granted a powerful choice. They can opt to receive either:
- Interest at 6% per year on their total unsettled amount.
- A share of the profits that the firm has earned since their retirement, calculated based on the proportion of their capital still being used in the business.
This provision ensures that continuing partners cannot unfairly profit from withholding funds due to the exiting partner.
