Dissolution of Partnership: Legal Process, Consequences, and Key Provisions

Theoretical overview

Dissolution of partners and dissolution of the partnership firm are two different concepts, as defined under section 39 of the Indian Partnership Act, 1932. The dissolution of partners means a change of business relationship between partners whereas the dissolution of a partnership firm means dissolving of the firm along with the relation between partners

Meaning of Dissolution of the Partnership firm: – Dissolution of a partnership firm means discontinuing the business under the name of the said partnership firm. It defines the dissolution of a partnership between all partners of a firm. When all activities in relation to the business cease and all the activities related to profit and loss are settled between the partners by repaying the debt, it is called dissolution of the partnership firm.

Meaning of Dissolution of partners: – Dissolution of the partners means a process by which the relationship between the partners is terminated and comes to an end and all the assets, shares, accounts and liabilities are disposed of and settled. The dissolution of a partners means termination of every contractual relationship between the partners. As the firm is still continued by the partner but the partnership between the partners has ended. The dissolution of the firm leads to the dissolution of partners. It is a contractual relationship between partners that works with the firm. If the firm is dissolved then the partnership between the partners is also dissolved.

Mode of dissolution of partnership firm

1. Dissolution by Agreement [Section 40]: – A firm can be dissolved with the consent of all partners or according to a contract between partners. The firm can be dissolved with the consent of all partners or by entering into an agreement to dissolve the firm. Any partnership firm can be dissolved by issuing a notice agreement to all the partners of the firm. If all the partners are in agreement on dissolution, then the partnership firm can be dissolved. This type of dissolution is the most common type and is called as voluntary dissolution.
2. Compulsory Dissolution [Section 41]: – If all the partners of the firm are declared as insolvent or even any one of them appear inactive at an unsound state of mind, then the partnership firm should be mandatorily dissolved. It is done by the adjudication that one or all partners of the firm become insolvent. If any such event happen which makes it unlawful to continue the business of the firm of the partnership.
3. Dissolution on the occurrence of certain contingencies [Section 42]: – when subject to a contract between the partners of the firm: –
   • If the firm is made for a limited period, by the termination of that term;
   • By the completion of all undertakings of the business;
   • By the death of a partner;
   • By the adjudication of the partner as insolvent.
4. Dissolution by Notice of partnership [Section 43]: – where the partnership is at the will of the firm, which may be dissolved by any partner by giving notice to all other partners, his intention to dissolve the firm.
5. Dissolution by Court [Section 44]: – At the suit of a partner, the court may order a partnership firm to be dissolved on any of the following grounds: –
   • when a partner becomes insane;
   • when a partner becomes permanently incapable of performing his duties as a partner;
   • when a partner is guilty of misconduct which is likely to adversely affect the business of the firm;
   • when a partner persistently commits breach of partnership agreement;
   • when a partner has transferred the whole of his interest in the firm to a third party;
   • when, on any ground, the court regards dissolution to be just and equitable;
   • If the firm continues to suffer losses, the court may order for the dissolution of the firm.

Consequences of dissolution of firm

1. Rights after dissolution [Section 46]: – It states that after the dissolution of a firm, all partners or its representatives are entitled to the assets of the firm, as the surplus to be distributed in payment of the firm’s debts and liabilities, and among all the partners of the firm.
2. Liabilities after dissolution [Section 45]: – According to this section, partners of the firm are liable for any actions of third parties unless they give public notice of the dissolution of the firm. It also states that a partner who dies, retire, and becomes insolvent or that person about whom the third party does not know that he/she is/was a partner in such a case that partner will not be liable for the action of the third party. In simple words, it protects third parties who do not know about the dissolution of the firm.
3. Settlement of accounts after the dissolution of the firm [Section 48]: – The firm will pay all losses, including the lack of capital out of profit and then from the partner’s capital and by the partners individually in their profit sharing ratio. The firm will use all their assets in paying all the debts to the third party, paying off loan or advances by the partner, paying back their capital and if all this any surplus left it will be divided between all the partners in their profit sharing ratio.
4. Return of premium after dissolution [Section 52]: – At the time of entering a partnership firm, the partner has to pay an amount in the form of a premium. Therefore when the firm is dissolved before the time period due to any reason, it is entitled to repayment of the premium. If the dissolution occur by the misconduct of the partner then he will not get the premium back.
5. Agreements in restraint of trade [Section 54]: – This means when one party agrees to restrict their freedom to do specific business with the other party, either in the present or future. This section defines that in anticipation of the dissolution of the firm, the partners enter into an agreement that some or all of the partners will not do any business similar to the firm for a specific period of time or even within specific local boundaries.
6. Sale of goodwill after dissolution [Section 55]: – Some methods of selling goodwill are: When the firm’s accounts are settled after dissolution, the goodwill will be subject to a contract between the partners, which will be included in the assets or will be sold separately or with the firm’s other assets.

Important difference

Relevant sections

• Section 40 dissolution by agreement.
• Section 41 compulsory dissolution.
•  Section42 Dissolution on the occurrence of certain contingencies
• Section 43 dissolution by giving a notice.
• Section 44 dissolution by court
• Section 45 liability of partners.
• Section 46 right of the partner.
•  Section 48 Settlement of accounts after the dissolution of the firm .
• Section 52 Return of premium after dissolution.
• Section 54 Agreements in restraint of trade.
• Section 55 Sale of goodwill after dissolution.

Important case laws

1. Airey vs. Barbam:

Facts of the case: – ‘A’ and ‘B’ enter into a five-year partnership. ‘A’ paid premium to ‘B’. The partnership was dissolved in two years as a result of disagreement by mutual consent, due to ‘A’ did not devoted time to the business.

Judgment of the case: – In this case, the court held that no part of the premium was payable, as the dissolution is caused by misconduct on the part of ‘A’.

2. Nowell vs. Nowell:-

Facts of the case: – ‘A’ and ‘B’ trade as partners and it is agreed that the profit should be shared and the loss should be shared equally. On dissolution it is found that ‘A’ has advanced more capital than ‘B’ to the extent of 1900 rupees. Net assets were only Rs. 400. Thus there is a shortage of capital of 500 rupees.

Judgment of the case: – In this case, the court held that under sub clause (a) both the partners have to contribute in the proportion in which they have agreed to share the profit equally. Therefore B should pay Rs. 250 to ‘A’.

Points to remember

• Dissolution of a partnership firm means discontinuing the business under the name of the said partnership firm. It defines the dissolution of a partnership between all partners of a firm. When all activities in relation to the business cease and all the activities related to profit and loss are settled between the partners by repaying the debt, it is called dissolution of the partnership firm.
• Dissolution of the partners means a process by which the relationship between the partners is terminated and comes to an end and all the assets, shares, accounts and liabilities are disposed of and settled. The dissolution of a partners means termination of every contractual relationship between the partners. As the firm is still continued by the partner but the partnership between the partners has ended. The dissolution of the firm leads to the dissolution of partners. It is a contractual relationship between partners that works with the firm. If the firm is dissolved then the partnership between the partners is also dissolved.
• Mode of dissolution of partnership are : dissolution by court, by agreement, by notice, compulsory dissolution, on the occurrence of certain contingency.