Partnership: Definition, Nature and Test

Partnership is the relation between persons who have agreed to share the profits of a business carried on by all or any of them acting for all (S.4, Indian Partnership Act, 1932). Persons who have entered into partnership with one another are called individually partners and collectively a firm, and the name under which their business is carried on is the firm name.

Legal Framework

Essential Elements

Why partnership cannot arise from status: S.5 was enacted to settle the position of the Hindu joint family business. Members of such a family carry on business together and share in its profits, but their relation arises from birth into the family, not from any agreement. Since partnership is founded on consent, and each partner binds the others by his acts, the law confines it to those who have chosen the relationship.

Mutual Agency: The True Test

Although the definition in S.4 mentions the sharing of profits, the decisive element is mutual agency: each partner is both a principal and an agent of the others in the business of the firm. Profit sharing is strong evidence of partnership but is not conclusive.

Determining Existence (S.6)

In determining whether a group of persons is a firm, regard must be had to the real relation between the parties as shown by all relevant facts taken together. The label the parties use is not decisive.

Cases Where Profit Sharing Does Not Create Partnership

Partnership Distinguished from Other Associations

Partnership at Will and Particular Partnership

Illustrations

1. Profit sharing without agency, no partnership: Creditors of a failing business take over its management through trustees and receive the net income towards their debts. Applying Cox v Hickman (1860), they are not partners, since the business is not carried on by or on behalf of them as principals.

2. Unequal management, partnership valid: A deed of partnership gives one of three partners exclusive control of operations and banking. Applying K.D. Kamath and Co v CIT (1971), the partnership is valid: participation in management is not essential so long as the managing partner acts for all.

3. Employee paid by profit share: A manager is remunerated by 10 percent of the net profits. Under S.6 Explanation 2 he is not a partner, because he works under direction and has no power to bind the firm.

4. Co-owners are not partners: Two brothers inherit a building and let it out, dividing the rent. Under S.6 Explanation 1 they are co-owners, not partners: there is no business carried on by mutual agency.

5. Hindu joint family business: A father and his sons carry on an ancestral cloth business. Under S.5 they are not partners, their relation arising from status. Should they execute a partnership deed among themselves, that agreement would create a partnership.

6. Particular partnership: Two builders agree to jointly execute one specific highway contract and share the profit on it, with no intention of continuing thereafter. Under S.8 this is a valid particular partnership which ends on completion of the contract.

7. Label not decisive: A document titled "Deed of Partnership" gives one party a fixed monthly sum with no share in profits or losses and no power to bind the business. Applying S.6, the real relation is that of a lender or employee and no partnership exists.

Recall Check

1. Why is mutual agency, rather than profit sharing, described as the true test of partnership?
2. Why does S.5 exclude the Hindu undivided family business from the definition of partnership?
3. Does a partner who takes no part in management cease to be a partner?

Key Cases

Cox v Hickman (1860) Cox v Hickman 1860
Issue: Whether creditors who received the profits of a business through trustees were liable as partners.
Rule: The true test is whether the business is carried on by or on behalf of the persons sought to be charged, that is whether mutual agency exists.
Held: The creditors were not partners; they received profits in payment of debts, not as principals carrying on business.

K.D. Kamath and Co v Commissioner of Income Tax (1971) KD Kamath and Co v CIT 1971
Issue: Whether concentration of management and control in one partner negatives partnership.
Rule: The essential conditions are an agreement to share profits and that the business is carried on by all or any of them acting for all.
Held: The partnership was valid; participation in management by every partner is not required.

Distinctions

Flashcards

Exam Scenario

Problem: Four arrangements come before you. First, Anil lends Rs. 20 lakhs to a garment business and, instead of interest, takes 15 percent of its net profits, with a right to inspect accounts but no say in operations. Second, Bina and Chetan inherit a warehouse jointly and let it out, dividing the rent equally. Third, a deed titled "Partnership Deed" between Dev, Esha and Farid provides that Dev alone shall manage the business, operate the bank accounts and take all decisions, while Esha and Farid contribute capital and receive fixed shares of profit and bear losses. Fourth, a father and his two adult sons carry on an ancestral jewellery business, all drawing from its profits. In each case a creditor of the business seeks to hold the individuals liable as partners. Advise.

Step 1: Fix the test you will apply to all four arrangements

The answer in every case turns on mutual agency, not on the presence of profit sharing and not on the label the parties used.

For each arrangement, ask in this order:

1. Is the business carried on by or on behalf of the person sought to be charged, as a principal? That is the test in Cox v Hickman (1860).
2. Has he power to bind the firm?
3. What is the real relation between the parties, whatever the arrangement is called?

Step 2: Anil, the lender who takes a profit share

Apply S.6 Explanation 2 and Cox v Hickman (1860). Receipt of a share of profits does not of itself make a person a partner.

Anil has no power to bind the firm and no role in operations. He receives profits in lieu of interest, in the character of a lender. He is not a partner and is not liable.

Step 3: Bina and Chetan, the co-owners of the warehouse

Apply S.6 Explanation 1. Sharing profits arising from joint property does not of itself make co-owners partners. There is no business carried on by mutual agency, only the passive exploitation of inherited property.

They are co-owners and not liable as partners. The distinguishing features confirm it.

Step 4: Dev, Esha and Farid, the deed with one managing partner

Apply S.4 and K.D. Kamath and Co v CIT (1971). There is an agreement to share profits and losses, and the business is carried on by Dev acting for all.

Concentration of management and banking authority in one partner does not negative partnership, because the managing partner acts on behalf of the others. That is precisely mutual agency.

All three are partners and each is liable to the creditor without limit.

Step 5: The ancestral jewellery business

Apply S.5. Partnership arises from contract, not status. The father and sons carry on an ancestral business by virtue of their position in the Hindu undivided family, so they are not partners as such.

Only the karta is personally liable, the coparceners being liable to the extent of their interest in the family property.

Conclusion. Only Dev, Esha and Farid are liable as partners. Anil is a lender within S.6 Explanation 2, Bina and Chetan are co-owners within S.6 Explanation 1, and the family business falls outside partnership by S.5. In every case the answer turned on mutual agency.

See Also

• Relations of Partners Inter Se : the rights and duties that follow once partnership is established.
• Relations of Partners to Third Parties : the operation of mutual agency in binding the firm.
• Limited Liability Partnership : the statutory alternative offering limited liability and separate personality.