The dissolution of a partnership firm means discontinuance of its activities. When the working of a firm is stopped and the assets are realized to pay various liabilities, it amounts to dissolution of the firm. The dissolution of a firm should not be confused with the dissolution of partnership. When partners agree to continue the firm under the same name, even after the retirement or death of a partner, it amounts to dissolution of partnership and not of firm.
dissolution of a partnership firm
The remaining partners may purchase the share of the outgoing or deceased partner and continue the business under the same name; involves only the dissolution of partnership. The dissolution of firm includes the dissolution of partnership too. The partners have a contractual relationship among themselves. When this relationship is terminated it is an end of the firm.
Study of Dissolution of A Partnership Firm
A firm may be dissolved under the following circumstances:
1. Dissolution by Agreement (Section 40). A partnership firm can be dissolved by an agreement among all the partners. Section 40 of Indian Partnership Act, 1932 allows the dissolution of a partnership firm if all the partners agree to dissolve it. Partnership concept is created by agreement and similarly it can be dissolved by agreement. This type of dissolution is known as voluntary dissolution.
2. Dissolution by Notice (Section 43). If a partnership is at will, it can be dissolved by any partner giving a notice to other partners. The notice for dissolution must be in writing. The dissolution will be effective from the date of the notice. In case no date is mentioned in the notice, then it will be dissolved from the date of receipt of notice. A notice once given cannot be withdrawn without the consent of all the partners.
3. Compulsory Dissolution (Section 41). A firm may be compulsory dissolved under the following situations.
(i) Insolvency of Partners. When all the partners of a firm are declared insolvent or all but one partner are insolvent, then the firm is compulsorily dissolved.
(ii) Illegal Business. The activities of the firm may become illegal under the changed circumstances. If government enforces prohibition policy, then all the firms dealing in liquor will have to close down their business because it will be an unlawful activity under the new law. Similarly, a firm may be trading with the businessmen of another country The trading will be lawful under present conditions.
After sometime a war erupts between the two countries, it will become a trading with an alien enemy and further trading with the same parties will be illegal. Under new circumstances the firm will have to be dissolved. In case a firm carries on more than one type of business, then illegality of one work will not amount to dissolution of the firm. The firm can continue with the activities which are lawful.
dissolution of a partnership firm
4. Contingent Dissolution (Section 42). In case there is no agreement among partners regarding certain contingencies, partnership firm will be dissolved on the happening of any of the situation.
(i) Death of a Partner A partnership firm is dissolved on the death of any of the partners.
(ii) Expiry of the Term. A partnership firm may be for a fixed period. On the expiry of that period, the firm will be dissolved.
(iii) Completion of Work. A partnership concern may be formed to carry out a specific work. On the completion of that work the firm will be automatically dissolved. If a firm is formed to construct a road, then the moment the road is completed the firm will be dissolved.
(iv) Resignation by a Partner. If a partner does not want to continue in the firm, his resignation from the concern will dissolve the partnership.
5. Dissolution through Court (Section 44). A partner can apply to the court for dissolution of the firm on any of these grounds:
(i) Insanity of a Partner. If a partner goes insane, then partnership firm can be dissolved on the petition of other partners. The firm is not automatically dissolved on the insanity of a partner. The court will act only on the petition of a partner who himself is not insane.
(ii) Misconduct by the Partner. When a partner is guilty of misconduct, the other partner can move the court for dissolution of the firm. The misconduct of a partner brings bad name to the firm and it adversely affects the reputation of the concern. The misconduct can be in business or otherwise. If a partner is jailed for committing a theft, it will also affect the good name of the firm though it has nothing to do with the business.
(iii) Incapacity of a Partner. If a partner other than the suing partner becomes incapable of performing his duties, then partnership can be dissolved.
(iv) Breach of Agreement. When a partner willfully commits breach of agreement relating to business, it becomes a ground for getting the firm dissolved. Under such situation it becomes difficult to carry on the business smoothly.
(1) Transfer of Share. If a partner sells his share to a third party or transfers his share to another person permanently, other partners can move the court for dissolving the firm.
(v) Regular Losses. When the firm cannot be carried on profitably, then the firm can be dissolved. Though there may be losses in every type of business but if the firm is incurring losses continuously and it is not possible to run it profitably, then the court can order the dissolution of the firm.
(vii) Disputes among Partners, Partnership firm is based on mutual faith. If partners do not trust each other, then it will not be possible to run the business. When the partners quarrel with each other, then the very basis of partnership is lost and it will be just to dissolve it.
Settlement of Accounts on Dissolution of a Firm
On the dissolution of partnership, the working of the concern is stopped. All the assets are realized and they are used to meet outside liabilities of the business. After paying outside creditors the balance amount is used to return loans of the partners and their capitals. In case the amount realized from assets is inadequate to meet the outside liabilities, then partners will contribute the deficit money from their private sources. The procedure adopted for settlement of accounts at the time of dissolution is as follows:
1. Any loss including deficiency will first be met out of profits of the firm and then out of the capitals if required. In case the deficiency is more than the amount of profits and capitals, then partners will contribute from the private estates in their profit sharing ratios.
2. All assets of the firm are realized and used in the following way.
(1) All outside creditors are paid at the first instance.
(ii) The loans of partners to the business in addition to their capitals are returned proportionately. (iii) The balance amount, if any, is used to return the capital of partners.
(iv) If there is any surplus after returning the capitals, the amount will be paid to partners in their profit sharing ratio.
If one partner is insolvent, then his deficiency is contributed by solvent partners in their capital balance ratio. All outside liabilities are met by solvent partners. Even if one partner is solvent outside liabilities will be paid in full.
dissolution of a partnership firm
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