Modes of Dissolution of a Firm

    INTRODUCTION

    With the changing times and advancement in technology, more and more companies and firms started to show up and it has become really important to regulate the functioning of these firms in India. Hence, the Indian Partnership Act, 1932 was brought into the picture. It is a well-known fact that Indian law is influenced by English law to a large extent and so is the case with the partnership law. The English Partnership Act, 1890 is based on precedents and customs. It will be wrong to assume that before the Partnership Act there was no law regulating the firms, rather the Indian Contract Act, 1872 contained a special chapter (CHAPTER XI) which was entirely dedicated to the laws governing partnership firms, nonetheless, it was not sufficient and needed alteration and hence, the Partnership Act, 1932 was formed and CHAPTER XI of the Contract Act was repealed.

    A firm will not be dissolved when only one or a few of the partners have ceased to carry their business rather when all the partners cease their right, it is then that a firm will be dissolved. The use of the word ‘all’ in section 39 signifies that the reader should understand that if there is some change or addition between the partners then the ‘partnership’ will be dissolved not the ‘firm’.

    In the case of Narendra Bahadur Singh v. Chief Inspector Of Stamps, U.P. [2], Allahabad High court elaborated on the concept of dissolution of the firm by saying, “…mere dissolution of a firm does not bring about a complete extinction of the firm itself. The firm, even though for the limited purposes mentioned in the relevant sections, continues to exist until its affairs are finally and completely wound up. It is only after the dissolution of the firm that its affairs can be wound up at the instance of any of the partners.”

    It is not easy to dissolve a firm. It is not like one fine day all the partners decide to cease their rights and liabilities and the firm is dissolved. A deed of dissolution is complex as it includes the matters which arise as a consequence of the dissolution of the firm. Outstanding payments, accounts settlement, closing down of business, etc., are some of the formalities which need to be taken care of. In this article, we will focus on the sections that talk about the modes/ways of dissolving a firm. And every section will be backed by case laws. However, if a partner retires, then his retirement will not be a ground for dissolution of the firm as the same can be backed by what Bhagwati J. observed way back in the case of Keshavlal Lallubhai v. Patel Bhailal Narandas [3], ……the law of partnership in India represents a compromise between the strict view of the English law which refuses to accord a legal personality to a firm and regards it merely as a compendious name for the partners and the mercantile usage which recognizes a firm as a distinct entity or quas-corporation…..”

     

    MODES OF DISSOLUTION OF A PARTNERSHIP FIRM

    Sections 40 to 44 are dedicated to the modes of dissolution of a firm. From here onwards we will understand these sections with the help of precedents by courts. There are five ways, which are as follows:

    DISSOLUTION BY AGREEMENT

    A firm may be dissolved with the consent of all the partners or by contact between the partners according to Section 40 of the Partnership Act. [4] This means that the presence of a contract between the partners which talks about the grounds for dissolution is important under this kind. If by any chance, no contract can back the dissolution, then based on the mutual agreement a firm can be dissolved.

    If one of the partners has become incapable to perform his/her duties due to reasons which may include dishonesty, unsoundness of mind, not able to physically carry out the task then by an express clause in the partnership agreement one of the partners can dissolve the partnership. One such case was Peyton v. Mindham [5]. In this case, both the plaintiff and the defendant were doctors and worked in partnership for several years. Both of them signed a deed, of which one of the clauses stated that if any of the partners fail to provide his services for consecutive 9 months then the other partner can send a notice to determine the partnership. The defendant decided to serve Peyton a notice, to which Peyton argued that it is invalid as he did not get a fair chance to prove that he is capable of working and Mindham’s assertion on his capability to work is baseless. The judge rejected this defence of Peyton as the defendant’s action was bona fide and the fact that the defendant acted on the deed signed gave him a ground to dissolve the partnership without court intervention.

    The dissolution of a firm should not be mistaken for reconstitution as both the terms have a different meaning. In the case of Commissioner Of Income Tax, West… v. Pigot Champan & Company [6], the apex court differentiated both the terms and made it clear by stating, “it cannot be disputed that ‘dissolution’ and ‘reconstitution’ are two distinct legal concepts, for, a dissolution brings the partnership to an end while a reconstitution means the continuation of the partnership under altered circumstances but in our view in law there would be no difficulty in a dissolution of a firm being followed by the Constitution of a new firm by some of the erstwhile partners who may take over the assets and liabilities of the dissolved firm.”

    COMPULSORY DISSOLUTION

    Section 41 of the Act reads as follows, “Compulsory dissolution.—A firm is dissolved,—

    (a) by the adjudication of all the partners or all the partners but one as insolvent, or

    (b) by the happening of any event which makes it unlawful for the business of the firm to be carried on or for the partners to carry it on in partnership:

    Provided that, where more than one separate adventure or undertaking is carried on by the firm the illegality of one or more shall not of itself cause the dissolution of the firm in respect of its lawful adventures and undertakings.”[7]

    According to this section, a firm can be dissolved on 2 grounds, namely:

    a) all the partners or of all the partners but one as insolvent.

    If we read the act properly, then we will find out that this clause of Section 41 is connected to Section 34(1) of the same Act which says, “Where a partner in a firm is adjudicated an insolvent he ceases to be a partner on the date on which the order of adjudication is made, whether or not the firm is hereby dissolved. [8]” It means that the moment a partner turns into an insolvent, he is not considered as a partner of the firm anymore as he is incompetent to contract, no matter the firm is dissolved or not. It is obvious that if all the partners become insolvent or out of all the partners only one is solvent then there is no partnership left between the partners.

    b) happening of any event which makes it unlawful for the business of the firm to be carried on

    A landmark judgment in the English law, which backs Section 41(b) of the Act is Espito v. Bowden[9] where both the plaintiff and the defendant chartered a ship to travel to Odessa to collect their cargo. During their voyage, a war broke out between England and Russia where the port was situated on enemy land. The partnership between the plaintiff and defendant stand dissolved as it was against the public policy of England.

    This provision is based on the Doctrine of Severability. The effect of this doctrine can be seen through Article 13 of the Indian Constitution. According to this doctrine if a law or a part of it is found to be unconstitutional or violates the fundamental rights of the citizen in any which way then that law or that part alone will turn as ineffective and the rest of the law will remain valid. Similarly, this provision states that if a firm has several businesses under it and one of them becomes illegal, then the other undertakings will remain valid and legal and only the illegal venture will be scraped out. R.M.D.C v. the State of Bombay [10] is one such landmark judgment where the court extensively talked about this doctrine.

     

    https://legalreadings.com/the-concept-of-judicial-precedents/

     

    DISSOLUTION ON THE HAPPENING OF CERTAIN CONTINGENCIES

    Section 42 provides that, subject to contract between the partners a firm is dissolved,— 

    (a) if constituted for a fixed term, by the expiry of that term;

    (b) if constituted to carry out one or more adventures or undertakings, by the completion thereof;

    (c) by the death of a partner; and

    (d) by the adjudication of a partner as an insolvent.” [11]

    Expiry of Fixed Term

    This clause is as simple as it sounds. It means that if a firm is formed for a limited period, then it will dissolve after its tenure has lapsed. This does not mean that the partners can never constitute a firm again, the same partners by mutual consent can continue their partnership.

    Completion of Adventures or Undertakings

    This clause applies to all those partnerships which are formed for more than one adventure or business and for such partnerships no fixed time is required. However, in such circumstances, the two main determinants of any partnership firm will be the kind of work undertaken by the firm and the behaviour/ conduct of the partners. Such firms dissolve on the competition of the task for which they have formed a partnership and it can either be one or more than one adventure. In the case of The Commissioner Of Income-Tax v. Memo Devi [12], T.V.R. Tatachari, C.J. quoted the Supreme Court judgment of  Commissioner of Income-tax v. Indira Balakrishna [13] and said, Therefore, an association of persons must be one in which two or more persons join in a common purpose or common action, and as the words occur in a section which imposes a tax on income, the association must be one the object of which is to produce income, profits or gains.” 

    Another famous case is of Gheru Lal Parekh v. Mahadeo Das Maiya [14], here, both the parties entered a wagering contract for the sale and purchase of wheat after facing losses for a long time, the contract terminated before the time. The Hon’ble Supreme Court of India said that without the realization of the assets firm cannot be dissolved.

    Death of a Partner:

    “Subject to the contract between the partners a firm is dissolved by the death of a partner.”

    This clause is one of the most prominent clauses of the Act. A firm is not a living person rather it is a group of people who come together to accomplish tasks undertaken.

    In case of the death of one of the partners out of the two partners, Madras High Court has clearly said, “A partnership normally dissolves on the death of the partner unless there was an agreement in the original partnership deed. Even assuming that there was such an agreement in a partnership consisting of two partners on the death of one of them the partnership automatically comes to an end and there is no partnership that survives and into which a third party can be introduced. Hence on the death of S, the original partnership was dissolved. The subsequent taking in of the assessee as a partner was only as a result of entering into a new partnership between R and the assessee. The partnership was not a matter of heritable status but purely one of contract” in the case of Smt. S. Parvathammal v. CIT [15] . The Supreme Court in the case of Mohd. Laiquiddin & Anr vs. Kamala Devi Misra (Dead) [16]. said, that with the death of one of the partners out of the two automatically dissolves the firm, this is notwithstanding any clause to the contrary in the partnership deed.

    Delhi High court, in the case of Sushil Kumar Gupta vs. Anil Kumar Gupta And Others [17], mentioned in the judgment, “Where the contract between the partners contemplates expressly or impliedly that the death of a partner would not result in the dissolution of the partnership firm, the said term in the contract is to be given effect to superseding the provision contained in Section 42(c).” 

    A similar kind of view was presented in the case of M.E.Narasimhan v. Messrs. Sri Balaji Chit by the Madras High Court as it stated, “The death of any one of the partners of a firm operates as a dissolution thereon as between all the members unless there is some agreement to the contrary. Whether there is a contract to the contrary is to be considered on the construction of the instrument of partnership.”

    Whether legal heirs of the deceased have the right to continue as the partners in the firm? This question was answered by a Division Bench of the Delhi High Court in the case of Additional Commissioner of Income Tax v. Sunder Lal Banwari Lal [18], as observed, “…Clause (c) of section 42 of the Partnership Act lays down that subject to a contract between the partners, a firm may be dissolved by the death of a partner. There is, however, an exception to the introduction of partners. If there is a contract between the original partners that the partnership should not be dissolved on the death of any of them and is to be continued with the legal heirs of the deceased partner after the death of the said partner, then the firm would continue to exist, otherwise not. The legal heirs of the deceased partner would become partners immediately after the death of the said partner with the result that he continues to remain in existence….”

    A combined reading of Sections 42 and 31 will tell us that a new member can only be added by the consent of the existing members of the firm. In Narayanan v. Umayal [19], Ramachandra Iyer J, very well said, “…if one of the partners died, there will not be any partnership existing to which the legal representatives of the deceased partner could be taken in. In such a case the partnership would come to an end by the death of one of the two partners, and if the legal representatives of the deceased partner join in the business later, it should be referable to a new partnership between therein.”

     

    DISSOLUTION BY NOTICE OF PARTNERSHIP AT WILL

    Section 43 states that

    (1) Where the partnership is at will, the firm may be dissolved by any partner giving notice in writing to all the other partners of his intention to dissolve the firm.

    (2) The firm is dissolved as from the date mentioned in the notice as the date of dissolution or, if no date is so mentioned, as from the date of the communication of the notice.” [20]

    As the section says, any partner can dissolve the firm by serving a notice, moreover, it needs to be taken care of that the notice should be in writing and expressly mention the dissolution of the firm and should be conveyed to all the members. In the case of Mc Leod v. Dowling [21], it was stated that, if a firm dissolves before the operative date of the notice then the notice will become ineffective as there will not exist any firm on which needs to be terminated. It is not that, out of all the partners, one fine day one partner feels like leaving the firm, and hence, he proposes dissolution. This right of dissolution by notice is only applicable when all the partners have mutually consented to the dissolution.

    The Gujarat High Court, in Manibhai Shankerbhai Patel v. Swashray Construction Co. And [22], explained that,  “Section 43 of the Partnership Act next provides that where the partnership is at will, the firm may be dissolved by any partner giving notice in writing to all the other partners of his intention to dissolve the firm. Once such a notice is given, the firm is dissolved as from the date mentioned in the notice as the date of dissolution or, if no date is so mentioned, as from the date of the communication of the notice. It is well-settled that if a suit is instituted for the dissolution of the partnership and rendition of accounts, the service of the summons along with the copy of the plaint on the other partners is a notice of dissolution within the meaning of Section 43 of the Partnership Act.” 

    Further, the Bombay High Court, in Dhulia-Amalner Motor Transport … v. Raychand Rupsi Dharamsi And Ors [23], said, “…The section requires three things: (1) the giving of notice, (2) the notice has to be in writing, and (3) the notice must express an intention to dissolve the firm. Unless these three requisites are complied with, the provisions of Section 43 of the Act would not come into operation at all.”

    DISSOLUTION BY COURT

    Section 44 provides that “At the suit of a partner, the Court may dissolve a firm on any of the following grounds, namely:—

    (a) that a partner has become of unsound mind, in which case the suit may be brought as well by the next friend of the partner who has become of unsound mind as by any other partner;

    (b) that a partner, other than the partner suing, has become in any way permanently incapable of performing his duties as a partner;

    (c) that a partner, other than the partner suing, is guilty of conduct which is likely to affect prejudicially the carrying on of the business, regard being had to the nature of the business;

    (d) that a partner, other than the partner suing, wilfully or persistently commits a breach of agreements relating to the management of the affairs of the firm or the conduct of its business or otherwise so conducts himself in matters relating to the business that it is not reasonably practicable for the other partners to carry on the business in partnership with him;

    (e) that a partner, other than the partner suing, has in any way transferred the whole of his interest in the firm to a third party or has allowed his share to be charged under the provisions of rule 49 of Order XXI of the First Schedule to the Code of Civil Procedure, 1908 (5 of 1908) or has allowed it to be sold in the recovery of arrears of land revenue or any dues recoverable as arrears of land revenue due by the partner;”

    (f) that the business of the firm cannot be carried on save at a loss; or

    (g) on any other ground which renders it just and equitable that the firm should be dissolved. [24]

    This section gives a right to the partners to plead before the court and get the firm dissolved on grounds of unsoundness of mind, permanent incapacity, misconduct, breach of the agreement. In Mrs. Sudhanshu Pratap Singh … v. Sh. Praveen (Son) it was expressly stated, “Section 44 of the Act is not made subject to the contract between the parties and gives the right to the partners to seek the assistance of the court for the dissolution of the partnership on the ground specified in the section. This section gives powers to the court to pass the decree of dissolution of the partnership firm. The power to dissolve the firm is vested in the court by this provision.”

    Temporary incapacity such as fracture, minor accident, etc., will not form grounds for dissolution unless the suffering of one partner is affecting the work of the firm for a very long time. In Harrison v. Tenant, Lord [25], Romilly said, “No party is entitled to act improperly and then to say that the conduct of the partners and their feelings towards each other are such that the partnership can no longer be continued and certainly this court would not allow any person to act and thus to take advantage of his wrong.” In case of misconduct the partner who is being questioned for the misconduct should be guilty of such wrongful behaviour which will affect the reputation of the business prejudicially.

    Concerning the clause (g) of the section the apex court has rightfully quoted the House of Lords in the Ebrahimi’s case [26] as follows, The foundation of it all lies in the words ‘just and equitable’ and, if there is any respect in which some of the cases may be open to criticism, it is that the Courts may sometimes have been too timorous in giving them full force. The words are a recognition of the fact that a limited company is more than a mere legal entity, with a personality in the law of its own; that there is room in company law for the recognition of the fact that behind it, or amongst it, there are individuals, with rights, expectations, and obligation inter se which are not necessarily submerged in the company structure.”

     

    CONCLUSION

    The author has attempted to make this an informative article on the modes of dissolution of a firm so that the readers can have a good understanding of the topic along with the sections of the Partnership Act. A firm is not said to be dissolved until all the partners stop carrying out their work. The case laws will help the readers in understanding not just the modes but, rights, liabilities, and obligation of partners in a firm.

    REFERENCES

    [1] The Partnership Act, 1932 (Act 09 of 1932),s.39.

    [2] AIR 1972 All 1.

    [3] AIR 1968 Guj 157.

    [4] The Partnership Act, 1932 (Act 09 of 1932),s.40.

    [5] (1971) 3 All ER 1215.

    [6] AIR 1982 SC 1085. 

    [7] The Partnership Act, 1932 (Act 09 of 1932),s.41. 

    [8] The Partnership Act, 1932 (Act 09 of 1932),s.34. 

    [9] (1857), 7 El. & Bl. 763.

    [10] 1957 AIR 699.

    [11] The Partnership Act, 1932 (Act 09 of 1932), s.42. 

    [12] ILR 1977 Delhi 1.

    [13] 1960 AIR 1172.

    [14] AIR 1959 SC 781.

    [15] 1987 163 ITR 161 Mad.

    [16] [2010]1 SCR873

    [17] 43 (1991) DLT 241.

    [18] 1985 156 ITR 617.

    [19] AIR 1959 Mad 283.

    [20] The Partnership Act, 1932(Act 09 of 1932), s.43.

    [21] (1927) 43 TLR 665.

    [22] (1982) 1 GLR 312.

    [23] AIR 1952 Bom 337.

    [24] The Partnership Act, 1932 (Act 09 of 1932), s.44. 

    [25] [1856] ALL ER 945.

    [26] [1973] AC 360.


    BY DEVANSHI POKHRIYAL | SYMBIOSIS LAW SCHOOL, HYDERABAD

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