A change in the membership of a firm reconstitutes it: the firm continues with a different composition. Dissolution of the firm under S.39 is different in kind: it ends the partnership between all the partners and the firm's business must be wound up. Distinguishing the two is essential, because the consequences for continuing liability, accounts and goodwill differ entirely.
Legal Framework
| Provision | Subject | Key Rule |
|---|---|---|
| S.31 | Introduction of a partner | No person may be introduced as a partner without the consent of all existing partners, subject to contract |
| S.32 | Retirement of a partner | A partner may retire with the consent of all, in accordance with an express agreement, or in a partnership at will by notice to all other partners |
| S.32(3) | Liability after retirement | A retiring partner continues liable to third parties until public notice of retirement is given |
| S.33 | Expulsion of a partner | A partner may be expelled only in exercise of a power conferred by contract and in good faith |
| S.34 | Insolvency of a partner | An insolvent partner ceases to be a partner from the date of the order of adjudication |
| S.35 | Liability of the estate of a deceased partner | The estate is not liable for acts of the firm after death |
| S.37 | Rights of an outgoing partner in subsequent profits | Where the business continues without settlement of accounts, the outgoing partner may claim a share of subsequent profits attributable to his share, or interest at six percent |
| S.39 | Dissolution of a firm | The dissolution of partnership between all the partners of a firm is called dissolution of the firm |
| S.40 | Dissolution by agreement | A firm may be dissolved with the consent of all partners or in accordance with a contract |
| S.41 | Compulsory dissolution | On all partners but one becoming insolvent, or on the business becoming unlawful |
| S.42 | Dissolution on the happening of contingencies | Expiry of the term, completion of the adventure, death of a partner, or insolvency of a partner, subject to contract |
| S.43 | Dissolution by notice of a partnership at will | Any partner may dissolve by giving notice in writing to all the other partners |
| S.44 | Dissolution by the court | On grounds of insanity, permanent incapacity, misconduct, persistent breach, transfer of interest, business at a loss, or just and equitable grounds |
| S.48 | Mode of settlement of accounts | Losses paid first out of profits, then capital, then by partners individually; assets applied in the prescribed order |
Reconstitution
Introduction of a Partner (S.31)
Subject to contract and to S.30 on minors, no person may be introduced as a partner into a firm without the consent of all existing partners.
Why unanimity is required: Every partner binds the others by his acts and is liable without limit for theirs. Admitting a new partner therefore imposes on each existing partner the risk of a colleague he did not choose. Unanimity is the only protection consistent with that exposure.
Retirement (S.32)
| Mode | Requirement |
|---|---|
| With the consent of all the other partners | Consent of every remaining partner |
| In accordance with an express agreement | As provided in the deed |
| In a partnership at will | Written notice to all the other partners of his intention to retire |
Continuing liability (S.32(2), S.32(3)): A retiring partner remains liable for acts of the firm done before his retirement, unless he is discharged by agreement with the remaining partners and the third party. He also remains liable to third parties for acts after retirement until public notice is given.
Why public notice is indispensable: Outsiders deal with a firm on the basis of its apparent composition. Until the change is publicised, a former partner continues to present himself to the world as a member, and a creditor extending credit on that footing is entitled to rely on it. The rule is the partnership counterpart of holding out under S.28.
Expulsion (S.33)
A partner may not be expelled by any majority of the partners except:
| Requirement | Explanation |
|---|---|
| A power of expulsion conferred by contract | The deed must provide for it |
| Exercised in good faith | For the benefit of the firm, not to serve the majority's private interest |
| In the interest of the partnership | The ground must relate to the firm's welfare |
| After notice and an opportunity to be heard | Natural justice applies |
Facts: A partnership deed empowered the partners to expel a partner guilty of a flagrant breach of duty or of conduct injurious to the business. A partner was convicted of travelling on the railway without a ticket with intent to defraud, and was expelled.
Issue: Was dishonesty unconnected with the firm's business a valid ground for expulsion under such a clause?
Held: The expulsion was valid. A conviction for dishonesty, even outside the firm's business, was conduct injurious to a business dependent on the confidence of customers. The power had been exercised in good faith and within its terms.
Relevance: The standard authority on the good faith requirement and on the breadth of conduct that may justify expulsion.
Rights of an Outgoing Partner (S.36, S.37)
| Right | Content |
|---|---|
| Right to carry on a competing business (S.36(1)) | Permitted, but he may not use the firm name, represent himself as carrying on the firm's business, or solicit its customers |
| Validity of agreements in restraint of trade (S.36(2)) | An agreement restraining him from carrying on a similar business within a specified period or local limits is valid if the restrictions are reasonable |
| Share in subsequent profits (S.37) | Where the business continues without a final settlement of accounts, he may claim either a share of profits attributable to his share of the firm property, or interest at six percent per annum on the amount of his share |
Why S.37 offers an election: The continuing partners are using the outgoing partner's capital in a business that may be profitable or may not. Giving him a choice between a profit share and a fixed six percent lets him take the better of the two, which removes any incentive for the continuing partners to delay settlement in the hope of retaining the benefit of his money.
Dissolution of the Firm
Distinguished from Dissolution of Partnership
| Basis | Dissolution of Partnership | Dissolution of the Firm (S.39) |
|---|---|---|
| Effect | The firm continues with the remaining partners | The firm ceases to exist |
| Business | Continues | Must be wound up |
| Accounts | Settled with the outgoing partner only | Full settlement among all partners |
| Also called | Reconstitution | Winding up |
Modes of Dissolution
| Mode | Provision | Content |
|---|---|---|
| By agreement | S.40 | Consent of all partners, or in accordance with a contract |
| Compulsory | S.41 | All partners but one adjudicated insolvent, or the business becoming unlawful |
| On contingencies | S.42 | Expiry of the fixed term, completion of the adventure, death of a partner, or insolvency of a partner, subject to contract |
| By notice | S.43 | In a partnership at will, by written notice by any partner to all the others |
| By the court | S.44 | On the grounds listed below |
Dissolution by the Court (S.44)
On a suit by a partner, the court may dissolve a firm on any of these grounds:
| Ground | Explanation |
|---|---|
| Insanity of a partner | Suit may be brought by any partner or by the next friend of the insane partner |
| Permanent incapacity | A partner has become permanently incapable of performing his duties |
| Misconduct | Conduct likely to affect prejudicially the carrying on of the business |
| Persistent breach of the agreement | Wilful or persistent breach, or conduct making it impracticable to carry on business with him |
| Transfer of the whole interest | A partner has transferred his whole interest to a third party |
| Business can only be carried on at a loss | The business cannot be carried on save at a loss |
| Just and equitable | Any other ground rendering dissolution just and equitable |
Facts: Six brothers ran two registered firms. Disputes went to arbitration, and the award dissolved the firms and allocated properties, including immovable properties, to individual brothers in satisfaction of their shares. It was objected that the award required registration because it dealt with immovable property.
Held: Property brought into the common stock or acquired for the firm belongs to the firm under S.14. Since S.48 requires the entire asset to be converted into money before the residue is divided, a partner's share is movable property. A partner has no definite or earmarked interest in any specific asset; his right is to profits during subsistence and to a share in the residue on dissolution. Allocation out of the residue is a mutual adjustment, not a transfer or partition, so no registration was needed.
Relevance: Cite on the treatment of firm property on dissolution, on the nature of a partner's interest as a share in the net proceeds rather than in specific assets, and on the non registrability of a dissolution deed or award distributing firm assets.
Settlement of Accounts (S.48)
Subject to agreement, on dissolution accounts are settled as follows:
Losses, including deficiencies of capital, are paid:
- First out of profits
- Next out of capital
- Lastly by the partners individually in the proportions in which they share profits
Assets, including any sums contributed to make up deficiencies, are applied:
- In paying the debts of the firm to third parties
- In paying each partner rateably what is due to him from the firm for advances as distinguished from capital
- In paying each partner rateably what is due to him on account of capital
- The residue divided among the partners in the proportions in which they share profits
Why third party creditors rank first: Outsiders dealt with the firm without any share in its profits and have no means of protecting themselves against the partners' internal arrangements. Partners, by contrast, accepted the risk of the venture. The order in S.48 reflects that partners are the last to be paid because they are the ones who chose to bear the risk.
Continuing Liability After Dissolution (S.45)
Notwithstanding dissolution, partners continue to be liable to third parties for any act done by any of them which would have been an act of the firm, until public notice of the dissolution is given.
Illustrations
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Introduction requires unanimity: Three of four partners wish to admit a fifth. The fourth objects. Under S.31 the admission cannot proceed, since consent of all is required.
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Retirement without public notice: A retires from a firm and informs the remaining partners but no public notice is given. A supplier who has dealt with the firm for years extends fresh credit believing A is still a partner. Under S.32(3) A remains liable to that supplier.
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Expulsion in good faith: A deed permits expulsion for conduct injurious to the business. A partner is convicted of a dishonesty offence unconnected with the firm. Applying Carmichael v Evans (1904), expulsion is valid, the firm's business depending on customer confidence.
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Expulsion in bad faith invalid: A majority expels a partner not for any misconduct but to appropriate his share of a profitable contract. The expulsion is invalid under S.33, not having been exercised in good faith.
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Outgoing partner's election under S.37: A retires but accounts are not settled and the business continues using his Rs. 20 lakh capital. He may claim either the share of profits attributable to his capital, or interest at six percent, whichever is more favourable.
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Reasonable restraint valid: A retirement agreement restrains the outgoing partner from carrying on a similar business within the same city for two years. Under S.36(2) the restraint is valid if reasonable, notwithstanding S.27 of the Contract Act.
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Dissolution by notice: In a partnership at will, one partner serves written notice on all the others of his intention to dissolve. Under S.43 the firm is dissolved from the date mentioned in the notice, or from the date of communication if none is mentioned.
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Compulsory dissolution for unlawfulness: A firm's sole business is rendered unlawful by new legislation. Under S.41 the firm is compulsorily dissolved.
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Settlement order: On dissolution the firm has Rs. 50 lakhs of assets, owes Rs. 30 lakhs to outside creditors, Rs. 8 lakhs to a partner for an advance, and Rs. 20 lakhs of capital. Under S.48 creditors are paid Rs. 30 lakhs first, then the Rs. 8 lakh advance, leaving Rs. 12 lakhs towards Rs. 20 lakhs of capital, so capital is returned rateably and the shortfall is borne in profit sharing proportions.
Recall Check
- Distinguish dissolution of partnership from dissolution of the firm.
- Why does a retiring partner remain liable to third parties until public notice is given?
- State the order in which assets are applied under S.48 and the reason for it.
Key Cases
Carmichael v Evans (1904) Carmichael v Evans 1904
Issue: Whether dishonesty unconnected with the firm's business justified expulsion under a clause permitting expulsion for conduct injurious to the business.
Rule: A power of expulsion must be conferred by contract and exercised in good faith and in the interest of the partnership.
Held: The expulsion was valid, a dishonesty conviction being injurious to a business dependent on customer confidence.
S V Chandra Pandian v S V Sivalinga Nadar (1993) SV Chandra Pandian v SV Sivalinga Nadar 1993
Issue: Whether a partner may claim specific assets of the firm on dissolution, and whether an award allocating firm immovable property requires registration.
Rule: Firm property under S.14 must be applied in accordance with S.48; a partner's interest is undefined and fluctuating, and his right is to a share in the residue, not in specific assets.
Held: The partner's claim was to a share in the net proceeds after settlement. Since the residue is movable property in law, the award distributing it required no registration.
Distinctions
| Basis | Reconstitution | Dissolution of the Firm |
|---|---|---|
| Continuity of the firm | Continues | Ceases to exist |
| Business | Carried on | Wound up |
| Provisions | S.31 to S.38 | S.39 to S.55 |
| Accounts | Settled with the outgoing partner | Settled among all partners under S.48 |
| Goodwill | Remains with the firm | May be sold under S.55 |
| Basis | Retirement (S.32) | Expulsion (S.33) |
|---|---|---|
| Initiative | The partner himself | The other partners |
| Requirement | Consent of all, agreement, or notice in a partnership at will | Power in the contract, exercised in good faith |
| Natural justice | Not applicable | Notice and opportunity to be heard required |
| Effect if invalid | Not applicable | The partner remains a partner |
| Basis | Dissolution by Notice (S.43) | Dissolution by Court (S.44) |
|---|---|---|
| Availability | Partnership at will only | Any firm |
| Requirement | Written notice to all other partners | Suit by a partner on statutory grounds |
| Grounds required | None | Insanity, incapacity, misconduct, persistent breach, transfer of interest, loss, or just and equitable |
| Effective date | Date in the notice, or date of communication | Date fixed by the court |
Flashcards
What is dissolution of a firm under S.39?
The dissolution of partnership between all the partners of a firm.
Can a new partner be introduced without the consent of all?
No. Under S.31 consent of all existing partners is required, subject to contract.
Until when does a retired partner remain liable to third parties?
Until public notice of his retirement is given (S.32(3)).
What are the conditions for a valid expulsion?
A power conferred by contract, exercised in good faith and in the interest of the partnership, after notice and an opportunity to be heard (S.33).
What are the outgoing partner's options under S.37?
Where the business continues without settlement of accounts, a share of subsequent profits attributable to his share, or interest at six percent per annum.
Name the grounds for dissolution by the court under S.44.
Insanity, permanent incapacity, misconduct, persistent breach of the agreement, transfer of the whole interest, business carried on only at a loss, and any just and equitable ground.
In what order are assets applied on dissolution?
Debts to third parties, then partners' advances, then partners' capital, and the residue divided in profit sharing proportions (S.48).
Is an agreement restraining an outgoing partner from competing valid?
Yes, under S.36(2), if the restrictions as to period and local limits are reasonable.
Exam Scenario
Problem: A firm of four partners, Priya, Qadir, Rohan and Sneha, is a partnership at will. Priya retires on 1 February, informing the other three but with no public notice given. On 1 April a long standing supplier, unaware of the retirement, supplies goods worth Rs. 7 lakhs on credit. In March the remaining partners, whose deed contains an expulsion clause for conduct injurious to the business, expel Qadir, their real motive being to take over a lucrative contract he had introduced. In May Rohan serves written notice on the others dissolving the firm. On winding up the firm has assets of Rs. 60 lakhs, outside debts of Rs. 45 lakhs, an advance of Rs. 5 lakhs made by Sneha, and total capital of Rs. 20 lakhs contributed equally. Advise all parties.
Step 1: Priya's retirement without public notice
Apply S.32(3). A retiring partner remains liable to third parties for acts of the firm after retirement until public notice is given.
No public notice was given, and the supplier dealt with the firm in ignorance of the change. Priya is therefore liable for the Rs. 7 lakhs jointly and severally with the others under S.25.
Informing the other partners is not enough. The notice must be public, because outsiders rely on the firm's apparent composition.
Step 2: Qadir's expulsion
Apply S.33. The deed conferred a power of expulsion and the clause was wide enough on its face, but the power must be exercised in good faith and in the interest of the partnership.
Carmichael v Evans (1904) is distinguishable. There the expulsion followed a genuine dishonesty conviction damaging to a customer facing business and was upheld. Here the motive was to appropriate the benefit of a contract Qadir had introduced, which is the majority serving its own interest rather than the firm's.
The expulsion is invalid. Qadir remains a partner and is entitled to be treated as such in the winding up.
Step 3: Rohan's notice of dissolution
Apply S.43. The firm is a partnership at will, so any partner may dissolve it by written notice to all the others.
The notice is effective and the firm stands dissolved from the date stated in it, or from the date of communication if none is stated. Qadir, whose expulsion was invalid, is a partner at dissolution.
Step 4: Settle the accounts under S.48
Apply the assets in this order:
- Debts of the firm to third parties.
- Each partner rateably for advances, as distinguished from capital.
- Each partner rateably on account of capital.
- The residue divided in profit sharing proportions.
| Step | Amount | Balance left |
|---|---|---|
| Assets available | Rs. 60 lakhs | Rs. 60 lakhs |
| Outside debts paid | Rs. 45 lakhs | Rs. 15 lakhs |
| Sneha's advance repaid | Rs. 5 lakhs | Rs. 10 lakhs |
| Capital of Rs. 20 lakhs, paid rateably | Rs. 10 lakhs | Nil |
Each of the four partners therefore receives Rs. 2.5 lakhs against a Rs. 5 lakh contribution, and the Rs. 10 lakh deficiency is borne in profit sharing proportions, equally in the absence of agreement.
The Rs. 7 lakh supplier debt forms part of the outside debts.
Both failures here, omitting public notice and using a contractual power for a collateral purpose, were avoidable.
Telling the partners is not public notice. S.32(3) requires public notice, so Priya stays exposed to a supplier who dealt with the firm in ignorance of her retirement.
A wide expulsion clause does not cure bad faith. S.33 requires both a contractual power and its exercise in good faith and in the interest of the partnership. A collateral motive defeats the expulsion however broad the wording.
An invalid expulsion leaves the partner in the firm. Qadir must be treated as a partner in the winding up and in the settlement of accounts, not as an outgoing partner.
Liability survives dissolution. Under S.45 partners remain liable to third parties for acts that would have been acts of the firm until public notice of the dissolution is given.
Conclusion. Priya is liable for the Rs. 7 lakhs, Qadir's expulsion is void so he shares in the winding up, and Rohan's notice validly dissolved the firm under S.43. Under S.48 creditors and Sneha's advance are paid in full, capital returns Rs. 2.5 lakhs each, and the Rs. 10 lakh shortfall is borne equally.
See Also
- Relations of Partners to Third Parties : the joint and several liability which continues until public notice is given.
- Relations of Partners Inter Se : the good faith duty which governs the exercise of a power of expulsion.
- Formation and Registration of Firm : the requirement to notify changes in constitution under S.63.