Consequences of Dissolution of a Firm | Indian Partnership Act

Partnerships, as defined under the Indian Partnership Act, 1932, are subject to dissolution under various circumstances. The dissolution of a firm triggers a series of legal consequences impacting partners, creditors, and the distribution of assets. Understanding these consequences is essential for navigating the process effectively and ensuring fair treatment for all parties involved.

Introduction

The alteration of relations among partners in a partnership firm can lead to its dissolution. If such dissolution results in the complete termination of the partnership, it constitutes the dissolution of the firm. The consequences of such dissolution are addressed in Chapter VI of the Partnership Act, 1932, spanning from section 39 to section 55. In this article, we will explore the ramifications of this dissolution.

Modes of Dissolution 

Before delving into the consequences of dissolving such a Partnership, let’s first discuss the modes of dissolving a partnership. The dissolution of a partnership firm can either be done with the order of a court or without its order, the provisions relating to the dissolution are included in sections 40 to 44 of the Act.

The mode of dissolution without the court’s order includes dissolution by an agreement (section 40), compulsory dissolution (section 41), dissolution on the happening of contingencies (section 42) and dissolution by notice of partnership at will(section 43).

Whereas mode of dissolution by court includes dissolution due to insanity of partner (section 44(a)), permanent incapacity of a partner (section 44(b)), partner guilty of misconduct (section 44(c)), willful and persistent breach of agreement (section 44(d)), transfer of interest (section 44(e)), business cannot be conducted (section 44(f)) or other grounds(section 44(g)).

Saligram Ruplal Khanna & Anr. v. Kanwar Rajnath, 1974 AIR 1094, the court said, 

"in accordance with the principle of law that a firm constituted for a fixed term shall stand dissolved, in the absence of a contract to the contrary, on the expiry of that term."

Consequences of Dissolution of a Partnership

A Dissolution of a firm results in the complete disintegration of relations between the partners of the firm. Such a dissolution comes with several consequences, the same will be covered here. Sections 45 to 49 cover the consequences of the dissolution of a partnership.

The liabilities which the Partners have to undertake even after the dissolution have been covered under Section 45 of the Partnership Act. In certain cases, a partner continues to be liable to the firm even after the firm has dissolved. Section 45(1) states that until a notice of dissolution is served to the public the partners of the firm will be liable for all the actions undertaken by them after such dissolution. Such acts of the partners refer to only those acts which would be if undertaken before the dissolution, an act of the partnership firm. However, this case does not apply to all partners, the partner who was declared insolvent a demised partner or a retired dormant partner won't be liable after the dissolution of the firm. The notice of the dissolution can be served by any of the partners(section 45(2)).

If a firm has any liability or debts continuing even after the dissolution, then how will such liabilities be met by the partners? The Right of partners to have business wound up after dissolution is covered under Section 46 of the Act. After the dissolution of the firm, all the partners or their representatives are entitled to apply the property of the firm to pay the debts and liabilities of the firm. Further, the partners or their representatives shall also have the right to share the surplus among themselves.

The authority of the partners does not always end with the dissolution. There are instances where such authority continues even after the dissolution. The continuing authority of the partners after the partnership has been dissolved is dealt with under section 47 of the Act. Until and unless the business of the firm is completely wound up or the unfinished transactions are completed, the partners shall continue to hold the rights and obligations as well as the authority to bind the firm even after the dissolution.

Section 48 of the Indian Partnership Act, 1932 deals with the settling of accounts between the partners after the firm dissolves. As already mentioned before, the property of the firm shall be used to meet the debts and liabilities of the firm. The losses of the dissolved firm are required to be met–

(i) First they are to be paid out of profits

(ii) Then they are to be paid out of capital and

(iii) Lastly in cases where the assets of the property fall short of the total debts and liabilities of the firm. Then in such a scenario, the partners are duty-bound to bear the deficiency.

The partners shall bear the deficiency in their profit-sharing ratio. The firm’s assets and the contributions of the partners are to be applied by the firm on the dissolution of the firm (section 48(b)). The assets and contribution are to be applied first in paying any debts to the third parties, then any dues payable to the partner for any advances or capital contributed by him and lastly the remaining shall be distributed among the partners in their profit sharing ratio.

In the case of Commissioner of Income-tax, Madhya Pradesh, Nagpur and Bhandara v. Dewas Cine Corporation, 1968 SCR (2) 173, the Hon’ble Supreme Court while discussing Sections 46 and Section 48 of the Partnership Act said:

The distribution of surplus is for the purpose of adjustment of the rights of the partners in the assets of the partnership; it does not amount to transfer of assets

Section 49 of the Indian Partnership Act deals with the payment of a firm's debts and separate debts. In case of joint or firm debts, the property of the firm is to be used in meeting the debts of the firm. Only after paying the debts, the surplus if any, shall be used in payment of their separate debts or to them. However in case where there is a private debt that is a debt of the partners, the same shall be met from the private property of the partners. If in case the firm has debts even after using the firm’s property, then the surplus private property shall be used.

Further in scenarios where a partner dies and the surviving partner (with or without the representative of the deceased) continues with the partnership, then as per Section 50 of the Partnership Act, the profits earned personally before the winding up of the firm shall be accounted.

In the event of a Partnership of a fixed term, wherein the partner had to enter the firm on the payment of a premium. In such instances, if a firm is dissolved before the completion of the term, then such a partner according to Section 51 of the Act shall have the right to receive the repayment of the premium so paid. However, this shall not apply in situations when the partnership is dissolved due to the misconduct of the said partner or when the dissolution agreement has no provision for the repayment of the premiums.

Section 52 of the Partnership Act deals with the rights when the partner is dissolved due to fraud or misrepresentation. In such scenarios the partner who brings an end to the partnership shall have a right over the assets of the firm after meeting the debts of the firm, such payment is paid to him for any prior capital contributed or share purchased for the firm. Further, such partner shall also have the right to rank, for any payment so made, as the creditor. Lastly, such a partner has the right to indemnity for all such acts of the partners.

After a firm is dissolved, every partner or his representative may, in the absence of a contract between the partners to the contrary, restrain any other partner or his representative from carrying on a similar business in the firm name or from using any of the property of the firm for his benefit, until the affairs of the firm have been completely wound up. (Section 53)

Further, the partners might also make an agreement restricting the partners from carrying on similar businesses for a certain period or within a certain locality (section 54). This section is subject to the provision of the Indian Contract Act, 1872. However, the restrictions must be reasonable.

Lastly, according to section 55, the goodwill of the firm can be sold after the dissolution of the partnership, along with other assets of the firm.

Conclusion

When a partnership is dissolved, the rights and liabilities do not end with it. In the dissolution of the partnership, the partners are entitled to further rights and obligations. The same was dealt with in this article vividly, covering the various aspects revolving around the dissolution of a partnership.

References

[1] Indian Partnership Act, 1932, Available Here

[2] Dissolution of a Partnership Firm: Meaning, Modes of Dissolution, Modes of Settlement of Accounts, Available Here

[3] Distribution of Assets of a Partnership Firm upon Dissolution, Available Here