The law relating to partnership firm in India is prescribed in the Indian Partnership Act of 1932. This Act lays down the rights and duties of the partners between themselves and other legal relations between partners and third persons, which are incidental to the formation of a partnership. Thus, the Act establishes the position of a partner as well as a partnership firm vis-à-vis third parties, in legal and contractual relations arising out of and in the course of the business of a partnership firm. In this article, we look at the various aspects of running a partnership firm in India in detail.
A partnership is a relationship between individuals who have agreed to share the profits of a business carried on by all or any one of them acting for all as stated in Section 4 of the Indian Partnership Act. Therefore, a partnership consists of three essential elements.
- A partnership must be a result of an agreement between two or more individuals.
- The agreement must be built to share the profits obtained from the business.
- The business must be run by all or any of them representing the rest.
All these conditions must coexist before a partnership can come into existence.
Essential Elements of a Partnership
Some key elements are required for the formation of a Partnership. They are listed below with a brief explanation.
A partnership is the result of an agreement between two or more persons. It should be noted that this sort of a deal can arise only from a contract and not from status. This is why a partnership is distinguishable from a Hindu Undivided Family carrying on family business. The reason is that this kind of an alliance is a creation only out of a mutual agreement. Thus, the nature of a partnership is voluntary and contractual.
An agreement from which a partnership relationship arise may be express. It may also be implied from the Partnership Act done by the partners and from a consistent course of conduct being followed, showing a mutual understanding between them. This agreement may be in oral or in writing.
Sharing Profit of Business
When it comes to sharing profits of the business, two propositions are to be considered.
Firstly, there must be a business that exists. For this purpose, the term ‘business’ would generally mean every trade, occupation, and profession. The existence of a company is crucial. The motive of a business is the “acquisition of gains” that leads to the formation of a partnership. So, there can be no partnership where there is no intention to carry on a business and to share the profits obtained from the same. For example, co-owners who share the rent derived from a piece of land are not considered partners as a business does not exist. Similarly, no charitable institution or club may be called a partnership. However, a Joint Stock Company may be floated as a partnership for non-economic purposes.
Secondly, there must be an agreement concerning the sharing of profits. For example, A and B buy certain bales of cotton which they agree to sell on their joint account and to share the benefits equally. In such a situation, A and B are partners in respect to the business they have planned out. However, an agreement to share the losses is not an essential element that is considered. However, in the event of damages, unless agreed otherwise, these must be borne in a profit-sharing ratio.
Running the Business
The third requirement for a partnership is that the business must be carried on by all the partners or by one or more of the partners acting for all. This is the crucial principle of the partnership law. An act of one partner in the course of the business of the firm is, in fact, an act of all partners. A partner carrying on a business is the principal as well as the agent for all the other partners. Therefore, it should be noted that the real test of a partnership is a mutual agency rather than sharing of profits. If the element of interactive agency is absent, then there will be no partnership. Sharing of benefits is the only Prima Facie evidence which can be rebutted by stronger evidence. This, this prima facie evidence can be countered by proving that there is no mutual agency.
Distinction between Partnership and Firm
Individuals who have entered into a partnership with one another are called Partners individually. The partners may be called collectively as the name under which the business is carried on is called the name of the Firm. A partnership is merely an abstract legal relationship between the partners. A firm is a concrete object signifying the collective entity for all the partners. Thus, a partnership is an invisible bind that holds the partner together, and a firm is the visible form of this partnership which is, therefore, bound together.
Types of Partnership
There are two types of partnership which are as follows.
Partnership at will
A partnership by will is a partnership where there is no provision made by contract between the partners for the duration of their partnership, or the determination of their partnership.
A particular partnership is when a person becomes a partner with another individual in a particular business enterprise or for a particular business venture or undertaking, such as the construction of a road, laying a railway line, etc. This sort of a partnership shall come to an end on the completion of the task for which it was initially formed.
Types of Partners
The different classes of partners can be derived based on the extent of liability in a partnership firm.
Active/ Actual/ Ostensible Partner
When a partner of a partnership firm,
- has become a partner by an agreement.
- actively participates in the conduct of the partnership.
The partner of the firm acts as a representative of other partners for all the acts carried out in the usual business lifecycle of the business. In the event of a retirement of a partner, the person must give a public notice to absolve himself of their liabilities for acts carried out by the other partners after his retirement.
Sleeping or Dormant Partner
A Sleeping or a Dormant Partner is a partner
- who is a partner by agreement;
- who does not actively take part in the conduct of the business.
These partners share their profits and losses and are liable to third parties for the business carried out by the partnership firm. However, they are not required to give public notice of their retirement from the partnership firm.
A nominal partner is an individual who lends his name to the partnership form. When this is done without having any real interest in the business, the person is a nominal partner. This kind of a partner is not entitled to share the profits of the firm. This partner has neither invested in the firm nor takes part in how the business is run at the firm. Although, such a partner is liable to third parties for all the actions taken by the firm.
Partner in Profits only
This is a partner who is entitled to have a share of the profits without being liable to the losses. This kind of a partner is liable to third parties only for acts of the gain.
A Sub-partner is a partner in a partnership firm who agrees to share his profits in a partnership firm with an outsider to the firm. A sub-partner does not hold any right against the firm nor is liable to any debts caused by the firm.
This is a partner who is admitted as a partner into an already existing firm with the consent from all the other existing partners. Such a partner is not liable for any acts of the form taken before his entry as a partner to the firm.
An outgoing partner is a partner who leaves the firm in which the rest of the partners continue to carry on the business. Such a partner remains liable to third parties for all the actions taken by the firm until a public notice concerning his retirement is given.
Partner by holding out (Section 28)
Partnership by holding out is also called as a partnership by estoppel. This is when an individual holds himself out as a partner or allows others to do so, the person is then stopped from denying the character he has assumed and upon the faith of which creditors may be presumed to have acted. When an individual represents himself or knowingly permits himself, to be represented as a partner in a partnership firm (when in fact he is not) he is liable, like a partner in the firm to anyone who on the faith of such representation, had given credit to the firm.
An individual may themselves, by their words or conduct has induced other to believe that they are a partner or they may have allowed others to represent them a partner. The result in both the situations is identical.
Partnerships vs. Company
The following are the differences between a partnership and different types of organizations.
|Legal Status||A firm is not a legal entity. Therefore, it has no legal identity distinct from the personalities of its constituent members.||A company is considered a separate legal entity distinct from its members.|
|Agency||In a firm, all the partners are an agent for each other, as well as of the firm.||In a company, a member is not an agent of any other member nor the company. A member’s actions do not bind either.|
|Distribution of Profits||The profits of a firm must be distributed among the partners according to the terms stated in the partnership deed.||There are no compulsions to distribute its profits among its members. A portion of the profits becomes distributable among the shareholders when dividends are declared.|
|Extent of Liability||In a partnership, the liability of the partners is unlimited. This means that every partner is liable for the debts of a firm incurred during the business of the firm. These debts may be recovered the partner’s private property if the joint estate is insufficient to meet the needs entirely.||In a company that is limited by shares, the liability of a shareholder is limited to the amount, if any, unpaid on his shares. In the case of a guarantee company, the responsibility is limited to the amount for which the shareholder has agreed to be liable. However, there may be companies where the liability of a member is unlimited.|
|Property||The firm’s property is that which is called a “Joint Estate” of all the partners. It does not belong to anybody distinct in law from its members.||In a company, its properties are separated from that of its members who can receive it back only in the form of a dividend or a refund of the capital.|
|Transfer of Shares||A share in a partnership can’t be transferred to another individual or partner without the consent of all the partners||A shareholder may transfer his shares, subject to the provisions contained in its Articles. In the case of a public limited company whose shared are quoted on the stock exchange, the transfer of shares is usually restricted.|
|Management||If there is no express agreement formed to the contrary, all the partners of the firm are entitled to participate in the control.||Company members are not entitled to participate in management unless they are appointed as a director. In such a case, they may participate. Members, however, enjoy the right of attending general meetings and voting where they can decide specific questions such as the election of directors, appointment of auditors etc.|
|Number of membership||For firms running a business other than banking, the number must not exceed 20. For banks, such a number must not exceed 10||A private company may have up to fifty members but not less than two. A public company may have how many ever members but not less than seven.|
|Duration of existence||If no contracts are existing to the contrary, death, retirement or an insolvency of a partner that results in the dissolution of a firm.||A company has the advantage of having perpetual succession.|
|Audit||The audit of the accounts of a firm is not compulsory.||The audit of the accounts of a company is obligatory.|
Partnership VS. Club
|Definition||A partnership is an association of individuals formed for earning profits from a business run by all or one representing the actions of all.||A club is an association of individuals with the objective not of earning a profit, but of promoting a beneficial purpose such as improvement of health or providing recreation for its members and so on.|
|Relationship||Individuals forming a partnership are called partners. A partner is an agent for all the other partners.||Individuals forming a club are called its members. A member of the club is not the agent of any other member in the same club.|
|Interest in the property||A partner has interest in the property owned by the firm.||A member of the club has no interest in any property owned by a club.|
|Dissolution||A change in the partners of a firm would affect its existence.||A change in the membership of the club does not affect its existence.|
Partnership VS. Hindu Undivided Family
|Basis||Partnership||Hindu Undivided Family|
|Mode of creation||A partnership is created through an agreement.||The right to a Hindu Undivided Family is formed by status. It is created by birth into such a family.|
|Death of a member||Death of a partner in the firm would lead to the dissolution of the partnership.||The death of a family member in a HUF does not end in the dissolution of the family business.|
|Management||All the partners of the firm are equally entitled to take part in a partnership business.||The right of management of a HUF is vested with the Karta, the governing male member of the family.|
|Authority to bind||By an act, a partner can bind the firm.||The Karta or the manager holds the authority to contract for the business and the rest of the members of the family.|
|Liability||The liability of a partner in a partnership is unlimited.||In a HUF, the liability of the Karta alone is unlimited. The rest of the co-partners are only liable to the extent of their shares in the profits of the family business.|
|Calling for accounts on the closure||A partner can file a suit against the firm for matters related to accounts, provided he also seek for the dissolution of the firm.||When a HUF splits up, a member is not entitled to ask for accounts concerning the family business.|
|Governing Law||The Partnership Act governs a partnership.||The Hindu Law governs a HUF.|
|Minor’s capacity||A minor cannot be a part of a partnership. Although, a minor can be admitted to the benefits of the partnership based on the consent of all the partners.||In a HUF business, a minor becomes a member of the family business by birth. The favour of the majority is not required to take part in the business.|
|Continuity||A firm gets dissolved by the death or insolvency of a partner subject to a contract between the partners.||A HUF can continue until it is divided. The states of a HUF is not affected by the death of a member.|
Partnership VS. Co-ownership
|Formation||A partnership is formed out of a contract.||Co-ownership is formed either from an agreement or by the operation of the law, such as by inheritance.|
|Implied Agency||A partner is an agent represent the other partners.||A co-owner is not a representative of other co-owners.|
|Nature of Interest||There is a community of interest which means that the profits and the losses have to be shared.||Co-ownership does not necessarily mean that the sharing of profits and losses have to involved.|
|Transfer of Interest||A share in a partnership is transferred only with the consent of the other partners.||A co-owner may transfer his share or interest or rights in a property without the consent of other co-owners.|
Partnership VS. Association
|Meaning||A partnership means and involves the setting up the relation of agency among two or more individuals who have entered in a business venture for the gains, with an intention to share profits of such a business.||Association evolves out of a social cause where there need not necessarily be a motive to earn or share profits. The intention is not to enter business for the gains.|
|Examples||A partnership is formed to run a business and earn a profit from the same.||Members of a charitable society, religious association, improvement scheme, building corporate, mutual insurance society or a trade protection association.|