Dissolution of a Firm
Section 39. Dissolution of a firm.
Dissolution of partnership means the termination of the partnership relationship between all the partners.
When this happens, the firm comes to an end.
This complete termination is called the Dissolution of the firm.
It is different from a change in constitution, where the firm continues with altered partners.
Section 40. Dissolution by agreement.
A firm may be dissolved with the consent of all the partners.
A firm may also be dissolved in accordance with the partnership contract.
So, Dissolution can occur either by mutual agreement or as per agreed terms
Section 41. Compulsory dissolution.
A firm is dissolved by:
(a).
A firm is dissolved if all the partners are adjudged insolvent.
A firm is also dissolved if all the partners except one are adjudged insolvent.
In either case, the firm cannot continue, leading to its dissolution.
(b).
A firm is dissolved if any event occurs that makes the firm’s business unlawful.
Dissolution also occurs if it becomes unlawful for the partners to continue carrying on the business in partnership.
The dissolution takes place from the time such illegality arises.
A firm may carry on more than one separate adventure or undertaking.
If one or more of these adventures become unlawful then:
That illegality does not automatically dissolve the entire firm.
The firm may continue in respect of its lawful adventures or undertakings.
Section 42. Dissolution on the happening of certain contingencies.
Subject to contract between the partners, a firm is dissolved:
(a). If the firm is constituted for a fixed term, then on the expiry of that term.
(b). If the firm is constituted for one or more specific adventures or undertakings then on the completion of such adventures or undertakings.
(c). On the death of any partner, the firm stands dissolved.
(d). When a partner is declared insolvent by a court, the firm is dissolved.
Section 43. Dissolution by notice of partnership at will.
43(1).
When the partnership is at will which means that the partnership has no fixed term or specific venture then:
In such a partnership, any one partner has the right to initiate dissolution.
The partner must decide to dissolve the firm voluntarily.
He must give a notice in writing.
The notice must be addressed to all the other partners of the firm.
The notice must clearly state the intention to dissolve the firm.
On giving such valid notice, the firm stands dissolved in accordance with the notice.
43(2).
A partner may issue a notice of dissolution.
The notice may specify a particular date as the date of dissolution.
If such a date is mentioned, the firm is dissolved from that specified date.
If no date is mentioned in the notice, then the firm is dissolved from the date on which the notice is communicated to the other partners.
The date of notice communicated to the other partners is when they receive the notice.
Section 44. Dissolution by the Court.
The Court may dissolve a firm if a partner files a suit and the following valid grounds are proved:
(a).
A situation may arise where a partner becomes of unsound mind.
In such a case, a suit may be filed before the court.
The suit may be brought by the next friend of the partner who has become of unsound mind.
Alternatively, the suit may be brought by any other partner of the firm.
(b).
A partner other than the one filing the suit may become incapable of performing his duties.
The incapacity must be permanent in nature.
Such incapacity may arise in any manner (Physical, Mental, or otherwise).
Because of this permanent incapacity, he is unable to discharge his duties as a partner.
In such a case, the affected partner or any other partner may seek appropriate relief from the court.
(c).
A partner other than the one filing the suit may engage in improper conduct.
The conduct must be such that it is likely to affect the business adversely.
The effect must be prejudicial to the carrying on of the business.
While judging this, the nature of the business must be taken into account.
If these conditions are met, a suit may be brought before the court for appropriate relief.
(d).
A partner other than the one filing the suit may act improperly.
The partner may wilfully (intentionally) or persistently (repeatedly) breach agreements.
The breached agreements must relate to:
The management of the firm’s affairs.
The conduct of the firm’s business.
Alternatively, the partner may conduct himself improperly in business matters.
Such conduct must make it not reasonably practicable for the other partners to continue the business together.
In such circumstances, the other partners may seek relief from the court (including dissolution).
(e).
A partner other than the one filing the suit may deal with his interest in the firm.
He may transfer the whole of his interest in the firm to a third party.
Alternatively, he may allow his share to be charged under Order XXI Rule 49 of the Code of Civil Procedure, 1908.
He may also allow his share to be sold for recovery of:
Arrears of land revenue.
Any dues recoverable as arrears of land revenue payable by him.
Such acts affect the partnership relationship.
In these cases, the other partner(s) may approach the court for appropriate relief, including dissolution.
(f).
The firm may be carrying on business.
However, the business may be in such a condition that it cannot continue without incurring losses.
The losses are not temporary or occasional, but indicate a continuing inability to operate profitably.
In such circumstances, continuation of the firm becomes commercially impracticable.
On this ground, a suit may be brought before the court for dissolution of the firm.
(g).
There may exist any other ground not specifically listed in the Act.
Such ground must make it just and equitable to dissolve the firm.
The court has wide discretionary power to assess the circumstances.
The court will consider fairness, equity, and justice between the partners.
If continuation of the firm would be unfair or unreasonable, the court may order dissolution.
Understanding Order XXI Rule 49
Order XXI Rule 49 deals with execution of a decree against partnership property.
Firm Property Is Protected
Partnership property belongs to all partners jointly.
Therefore, no creditor can touch firm property unless the decree is against the firm itself.
This prevents one partner’s personal creditor from harming the others.
So , if a decree is passed only against an individual partner,
The creditor cannot directly attach or sell:
Firm assets, or Firm property.
Remedy Available to the Creditor: Charging Order
Since direct attachment is barred, the law gives an alternative remedy.
The decree-holder may apply to the court for a charging order.
A charging order does not affect firm property, but only: The partner’s share in the firm.
The charge can cover:
The partner’s interest in the firm, and his share of profits.
The creditor can claim only what the partner himself would receive, nothing more.
Role of the Court
To enforce the charge, the court may:
Appoint a receiver to collect the partner’s share of profits.
In suitable cases, order sale of that partner’s share.
The firm’s business continues uninterrupted.
Protection Given to Other Partners
The remaining partners are not left helpless.
They have the right to redeem (pay off the debt), or purchase the charged share themselves.
This prevents outsiders from interfering in the partnership.
Section 45. Liability for acts of partners done after dissolution.
45(1).
Dissolution of the firm does not automatically end partners’ liability.
Partners remain liable to third parties for acts done by any partner.
The acts must be such that they would have been acts of the firm before dissolution.
This liability continues until public notice of dissolution is given.
The estate of a partner is not liable for acts done after the partner ceases to be a partner.
This exemption applies in the following cases:
Death of a partner.
Adjudication of a partner as an insolvent.
Retirement of a partner, where the partner was not known as a partner to the person dealing with the firm.
In all these situations, liability ends from the date the partner ceases to be a partner.
45(2).
Notices under 45(1) can be given by partner.
Section 46. Right of partners to have business wound up after dissolution.
On dissolution, every partner or their representative has a right against the other partners.
The property of the firm must first be used to pay the debts and liabilities of the firm.
After all liabilities are settled, the surplus (remaining assets) is to be distributed among the partners or their representatives.
The distribution is done according to each partner’s rights or agreed share.
Section 47. Continuing authority of partners for purposes of winding up.
After dissolution, a partner’s authority to bind the firm generally ends.
However, such authority and mutual rights continue for limited purposes.
They continue only as far as necessary to wind up the affairs of the firm.
They also continue to complete transactions that began before dissolution but were not finished.
No authority exists beyond these purposes so no new business can be undertaken.
The firm is not bound by acts of a partner who has been adjudicated insolvent.
Any act done by such an insolvent partner does not bind the firm.
This rule does not protect a person who:
Represents himself as a partner of the insolvent, or knowingly allows himself to be represented as such.
Such a person remains liable for acts done on that representation.
Section 48. Mode of settlement of accounts between partners.
While settling the accounts of a firm after its dissolution, the following rules shall apply, unless the partners have agreed otherwise:
(a).
Any losses of the firm, including deficiencies of capital, shall be settled in the following order:
First, out of the firm’s profits.
If profits are insufficient, out of the firm’s capital.
If still insufficient, by the partners individually, in the same proportion in which they were entitled to share profits.
(b).
When a firm is dissolved, the money and property of the firm and assets are used in a fixed order so that everyone is paid fairly.
(i). Payment of outside debts first
The firm must first pay all amounts owed to third parties, such as suppliers, lenders, or creditors who are not partners.
So, Outsiders get priority over partners.
(ii). Repayment of partners’ advances
Next, the firm repays partners for any advances or loans they gave to the firm over and above their capital contribution.
These are treated like loans, not ownership capital, and are paid proportionately.
(iii). Return of partners’ capital
After advances are cleared, the firm returns each partner’s capital contribution.
If there is not enough money, it is distributed proportionately among the partners.
(iv). Distribution of surplus (if any)
If any assets remain after paying debts, advances, and capital, the remaining balance is divided among the partners.
This division is done in the same ratio in which the partners shared profits.
Section 49. Payment of firm debts and of separate debts.
When both the firm and the individual partners have debts, the law fixes a clear order for using property.
If there are joint debts (debts owed by the firm) and also separate debts (personal debts of a partner), the firm’s property is used first.
The firm’s property must be applied first to pay the firm’s own debts, that is, debts owed to third parties by the firm as a whole.
Only after all firm debts are paid, if there is any surplus left, each partner’s share in that surplus is considered.
That partner’s share is then used to pay his personal (separate) debts, if any.
If the partner has no separate debts, or after those debts are paid, the remaining amount is paid to the partner.
Section 50. Personal profits earned after dissolution.
If a firm is dissolved because a partner dies, the business does not come to an immediate legal end for all purposes.
Unless the partners have agreed otherwise, the rule in section 16(a) continues to apply.
This rule applies to any transactions carried out after dissolution but before the firm’s affairs are fully wound up.
It covers transactions done by:
The surviving partner(s).
The legal representatives of the deceased partner.
So, if any of them makes a profit by using the firm’s property, name, or business connection during this interim period, then:
They must account for and share those profits with the firm or the other partners.
If a partner or the legal representative of a deceased partner has purchased the goodwill of the firm,
Then this rule does not restrict that person’s rights.
Such a buyer is entitled to use the firm’s name as part of the goodwill.
Section 51. Return of premium on premature dissolution.
When a partner joins a firm for a fixed period, he may pay a premium (an extra amount) to become a partner.
If the firm is dissolved before the fixed term ends, and the dissolution is not due to the death of a partner, then:
That partner is entitled to get back the premium, either in full or in part.
The amount to be refunded will be what is reasonable, considering:
The terms and conditions on which he became a partner.
The length of time he actually remained a partner in the firm.
The partner will not be entitled to a refund of the premium if:
(a). The dissolution of the firm is mainly caused by his own misconduct.
(b). The dissolution takes place under an agreement that does not provide for the return of the premium or any part of it.
Section 52. Rights where partnership contract is rescinded for fraud or misrepresentation.
If a partnership agreement is cancelled because one party committed fraud or misrepresentation.
The party who cancels the contract is entitled to certain rights, without losing any other legal remedies available to him.
(a).
The affected party has a lien (legal claim) or right to retain the firm’s surplus or remaining assets,
This applies after all the firm’s debts have been fully paid.
The right exists to recover:
Any amount he paid to buy a share in the firm, and any capital he contributed to the firm.
(b).
The affected party will be treated as a creditor of the firm for any amount he has personally paid towards the firm’s debts.
(c).
The affected party has the right to be indemnified (fully compensated) by the partner or partners who committed the fraud or misrepresentation, for all the debts of the firm.
Section 53. Right to restrain from use of firm name or firm property.
Once a firm is dissolved, and if there is no agreement between the partners stating something else:
Any partner or the legal representative of a partner has the right to stop (restrain) another partner or his representative from:
Carrying on a similar business in the firm’s name.
Using any property of the firm for personal benefit,
This restriction continues until the firm’s affairs are fully wound up.
If a partner or the legal representative of a partner has purchased the goodwill of the firm then:
Then this rule does not apply to him and he is free to use the firm’s name as part of the goodwill.
Section 54. Agreements in restraint of trade.
When a firm is about to be dissolved, or is expected to be dissolved, the partners may enter into an agreement that:
)ne or more of them will not start or run a similar business.
This restriction can be:
For a specified period of time, and/or within specified local or geographical limits.
Even though the Indian Contract Act generally treats restraints on trade as void,
Such an agreement is legally valid in this case as long as the restrictions are reasonable.
Section 55. Sale of goodwill after dissolution. Rights of buyer and seller of goodwill. Agreements in restraint of trade.
55(1).
When a firm is dissolved and its accounts are settled:
The goodwill of the firm is treated as part of the assets, unless the partners have agreed otherwise.
This goodwill can be sold on its own or sold together with the other property of the firm.
55(2).
After a firm is dissolved, its goodwill may be sold to a buyer.
Even after the goodwill is sold, a former partner is allowed to start or run a competing business.
He is also free to advertise his new business.
However, unless there is an agreement allowing it, the former partner cannot:
(a). Use the old firm’s name;
(b). Represent or claim that he is continuing the business of the dissolved firm; or
(c). Approach or solicit customers who were dealing with the firm before its dissolution.
55(3).
When the goodwill of a firm is sold:
Any partner may enter into an agreement with the buyer of the goodwill that he will not start or carry on a similar business.
This restriction may apply:
For a specified period of time, and/or within specified geographical (local) limits.
Even though restraints on trade are generally void under the Indian Contract Act,
Such an agreement is legally valid if the restrictions are reasonable.
