A Legal Guide to Dissolution of Partnership Firm

The process of dissolution of a partnership firm results in the dissolution of the relationship between the partners existing in a firm. Hence if the partnership between the existing partners in a firm is dissolved or terminated or it comes to an end, it is known as the dissolution of a partnership firm. In the scenario of the dissolution of a partnership firm, the firm ceases to exist. 

The process of dissolution of a partnership firm involves the assessment of the assets and liabilities of the business and settlement of the accounts, assets, and liabilities. 

We are aware that subject to the registration of a firm, the dissolution of a partnership firm alters and changes the relationship between the partners, but the firm remains intact and so do its activities. The reasons for the dissolution of a partnership firm are as follows: – 

• Any alteration of the existing profit-sharing ratio
• Admission of a new partner 
• Retirement of any partner
• Death of a partner
• Insolvency of a Partner
• Completion of a specific objective in a Particular Partnership
• Expiry of the term in Particular Partnership

Section 39 of the Indian Partnership Act 1932 provides that the dissolution of a partnership firm amongst all the partners of the firm is the Dissolution of the Partnership Firm. Post the dissolution of the partnership firm, its existence comes to an end.|

Post this, the firm cannot perform or enter into any transaction with anyone. However, the firm is enabled to analyze and sell its assets for the collection of amounts to pay off its liabilities. 

It is also pertinent to note that while the dissolution of a partnership amongst all the partners results in the dissolution of a partnership firm but a dissolution of a partnership doesn’t result in the dissolution of a partnership firm. The contrary is possible.

The distinction between Dissolution of a Partnership Firm and Partnership

Dissolution of a Partnership Firm results in the business ceasing to exist, whereas dissolution of a partnership merely changes the relationship between the partners. 

In the circumstance where one partner dies, retires, or becomes insolvent but the rest remain in the business with a consensus to carry on the business, then the business continues with an alteration in the relationship between the partners. That is the dissolution of a partnership, not the dissolution of a partnership firm. 

However, the dissolution of a partnership firm ends the business, meaning that the business ceases to exist, and the liabilities are paid off by selling the assets of the business. The dissolution of a partnership among all the partners of the firm is called the dissolution of a partnership firm. 

Ways of Dissolution of Partnership Firm

1. Dissolution by Agreement – Dissolution of a partnership firm may happen if all the partners mutually agree to dissolve the firm. In the case where a contract exists dictating the terms of dissolution, the dissolution may take place in accordance with the contract. 

2. Compulsory Dissolution – A dissolution of a partnership firm happens compulsorily if: 
   • All the partners become insolvent, or all the partners but one become insolvent. This incapacitates them from entering into a contract. 
   • The business of the firm becomes illegal. 
   • Under certain circumstances, it becomes unlawful for the partnership firm to carry on its business. For example, if another country declares war against India and the firm consists of partners from both jurisdictions, then the business becomes unlawful as the partner belongs to the enemy country. 

3. Dissolution due to Contingency – This is when an existing contract gives effect to the dissolution of a partnership firm. The dissolution of a partnership firm happens if: 
   • The firm is created for a fixed period of time, leading to its expiration. 
   • The firm is formed with a specific object. Upon completion of the object, the firm expires. 
   • The partners die
   • The partners become insolvent.

4. Dissolution by Notice – This is when in a partnership that is formed with mutual consensus, a partner gives a notice in writing to the other partners showcasing his intention of dissolving the firm. 

5. Dissolution by Court – When the court orders the dissolution of a firm on the following grounds: 

• Where a partner becomes insane
• When a partner becomes permanently incapable of performing his duties
• When a partner is guilty of misconduct, it impacts the business adversely 
• When a partner consistently breaches the partnership deed. 
• When a partner transfers his entire interest in the business to a third party 
• Where a business cannot be carried except at a loss
• When the court determines that the dissolution of a partnership firm is just and equitable on any grounds upon their discretion.

Settlement of Accounts

In a scenario where the partners are not in agreement on the subject of  the dissolution of a firm, the following provisions of the Indian Partnership Act 1932 will be applicable:

The firm will pay the losses, including the deficiency of capital, firstly out of the profits, secondly out of the partner’s capital, and lastly by the partners individually in their profit sharing ratio.

The firm shall apply its assets, including any contribution, to make up for the deficiency, firstly by paying the third party debts, secondly by paying any loan or advance by any partner, and lastly by paying back their capital. Any surplus left after all the above payments are shared by partners in the profit-sharing ratio.

Conclusion

Now, as we know, the process of dissolution of a partnership firm results in the dissolution of the relationship between the partners existing in a firm. Hence if the partnership between the existing partners in a firm is dissolved or terminated or it comes to an end, it is known as the dissolution of a partnership firm. In the case of the dissolution of a partnership firm, the firm ceases to exist. 

Further, the five ways of dissolution are dissolution by mutual agreement, dissolution by notice, dissolution by the court, dissolution by contingency, and compulsory dissolution. To know more about the process of dissolution of a partnership firm and its requirements of it, get online legal advice.