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Tuesday, November 26, 2013

Partnershp Firm : Reconstitution

A partnership is said to be reconstituted on any of the following changes occurring and the firm continuing its business:
  • Introduction of a new partner; and
  • Retiring of an existing partner.
i.    Introduction of a New Partner
A new partner can be inducted:
  • With the consent of existing partners; and
  • In accordance with the contract.
According to Section 31(ii), a new partner is not liable for the debts incurred before he joined the firm. However, by novation – i.e., by a tripartite agreement between the creditors of the firm, partners existing at the time the debt was incurred, and the incoming partner – the new partner can be made liable. A lending banker has to pay great attention to these changes for it impacts the debt servicing capacity of the firm.

ii.   Retiring of an Existing Partner
An existing partner can walk out of a firm owing to any of the following happenings:
By Retirement
  •  A partner can leave the firm by retirement.
  • But he remains liable for the acts of the firm done before he retired.
  • Also, he continues to be liable for the acts of the firm carried out after his retirement too until the date of public notice.
  • Similarly, the firm shall continue to be liable for the acts of the retired partner done within his implied authority till the date of the public notice.

Box 7: Outgoing Partner – How Important to the Lending Bank
Usually, a lending banker releases the retiring partner if he chooses to accept the newly constituted firm as his debtor in the place of the old firm. However, if he elects not to relinquish his claim against the retiring partner, he has to close the old account and route subsequent transactions through a new account so as to avoid the application of the rule in Clayton’s case, according to which, a payment shall discharge the earliest debt, whether of the customer or of the banker, remaining unpaid.

To allow or not to allow credit facilities under circumstances of this nature much depends on:
  • The importance of the outgoing partner for the successful running of the firm.
  • The effect of the proposed pay-outs, if any, to the retiring partner on the financial viability of the firm.
  • The ability of the remaining partners, both in terms of managerial and financial strength, to carry on the business of the firm successfully.

By Expulsion
The existing partners can expel a partner from the firm. The liabilities of such an expelled partner will however, remain as above.

By Insolvency
  • An insolvent ceases to be a partner on the date on which the order of adjudication is made.
  • The estate of the insolvent is not liable for any act of the firm subsequent to the date of order of adjudication even if the public notice is not given.
  • Subsequent to the date of order of adjudication, the firm cannot be made liable for any act of the insolvent partner. Hence, the banker returns the cheque signed by the insolvent partner and received by the bank after he has been adjudicated to be insolvent.

By Death
  • The death of a partner dissolves the partnership unless there is agreement to the contrary.
  • The estate of the deceased is not liable for any act of the firm done after his death.
  • There is no need for a public notice in this case.

Box 8: Deceased Partner – Rights of Legal Heirs on the Firm
The legal heirs of the deceased partner can only claim the deceased partner’s share in the assets. A lending banker, obviously, needs to critically examine the impact of such pay-outs on the successful functioning of the firm.

If the firm’s account is in debt, the banker should stop the transactions in that account to fix the liability of the estate of the deceased partner as also to avoid the operation of the rule in Clayton’s case.

If the lending banker is confident of the remaining partners’ ability to run the firm and feels that they are worthy of credit support, he may allow operations in the old account subject to the continuity of the firm.

iii. Revocation of Continuing Guarantee (Section 28)
Unless otherwise agreed, a continuing guarantee given to a firm or to a third party in respect of the transactions of a firm stands revoked as to future transactions from the date of change in the constitution of the firm.

2. Dissolution of a Partnership Firm
Dissolution means termination of relationship of all the partners as partners. It is to be appreciated that dissolution of partnership and dissolution of a firm are two different things. Dissolution of partnership may mean severance of connection of one partner with the firm while the firm continues to exist. Dissolution of firm means complete breakdown of the relationship between all the partners of the firm as partners (Section 39). In other words, it means mere incoming or outgoing of partners does not cause dissolution of a firm.

Dissolution and winding up are two different things. While dissolution refers to the termination of relationship, winding up refers to the final settlement of rights and liabilities of the partners. In the case of companies that are under liquidation, their affairs are first wound up and then dissolved. But in the case of a firm, winding up is treated as part and parcel of dissolution, but not a distinct transaction.

Firms are dissolved in the following ways:

By Agreement (Section 40)
A firm may be dissolved with the consent of all the partners or in accordance with a contract between the partners.

By Court Order (Section 44)
A partner has got a right to seek assistance of the court to have the firm dissolved when:
  • a partner becomes unsound of mind;
  • a partner becomes incapable of performing his duties as a partner;
  • a partner is guilty of conduct which is likely to affect prejudicially the carrying on of business;
  • a partner wilfully commits a breach of agreement;
  • a partner transfers the whole of his interest to a third party;
  • the business can be carried on only at a loss; or
  • an act or happening which renders it just and equitable that the firm should be dissolved.
By Compulsory Dissolution (Section 41)
A firm is dissolved compulsorily:
  • Upon adjudication of all the partners or all the partners but one as insolvent; or
  • When an event, which makes it unlawful for the business of the firm to be carried out or for the partners to carry it on in partnership, happens.
By Dissolution of Partnership at Will (Section 43)
Partnership firms formed with no contract between partners for dissolution or for its termination may be dissolved by any partner giving notice in writing to all the other partners of his intention to dissolve the firm.

3. Rights and Liabilities of Partners after Dissolution
Partners continue to be liable for the actions of the firm until the public notice of dissolution is given. However, the continuation of a liability for want of public notice does not apply in the case of death or insolvency of a partner.

As for rights, Section 46 states that, on dissolution, every partner is entitled to have the property of a firm applied in payment of the debts and liabilities of the firm and to have the surplus distributed among the partners according to their rights.
Section 48 provides general rules for settling the accounts of a firm after dissolution:

  1. Losses including deficiencies of capital shall be paid first out of profits, next out of capital, and lastly, if necessary, by the partners individually in proportion to their entitled share in the profits.
  2. The assets of the firm, including capital contribution, shall be applied in the following manner and order:
  • In paying the debts of the firm to third parties;
  • In paying to each partner ratably what is due to him from the firm for advances;
  • In paying to each partner ratably what is due to him on account of capital; and
  • The residue among the partners in proportion to their share in the profit.
  1. Where there are joint debts due from the firm and separate debts due from any partner, the property of the firm shall be applied in the first instance in payment of debts of the firm.


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