Starting a partnership is often a joint, well-considered decision but there may come a time when the partners decide that it is better to bring the business to an end. Falling profits, disagreements among partners or a simple decision to move on can all lead to the dissolution of a partnership firm. Dissolving a partnership firm is more than just stopping business operations.
It involves closing the firm’s financial affairs, recovering/selling its assets, clearing outstanding liabilities and making final settlement of accounts among partners. A partnership can be dissolved in several ways, depending on situation. In this article, we will explain different methods of partnership dissolution and how each method works.
Partnership firm dissolution refers to process of legally bringing partnership firm to an end. This process generally happens when partners jointly decide to discontinue business. It may also happen when firm is required to be dissolved due to certain circumstances, such as death or insolvency of a partner or other circumstances provided under law or partnership deed.
Once the firm is dissolved, its business activities are brought to an end and process of settling the firm's affairs begins. This includes selling or otherwise disposing of firm's assets, paying its outstanding debts and liabilities and settling remaining amount among partners. Any profit or loss arising during this process is generally shared by partners in accordance with the profit-sharing ratio agreed upon by them.
A firm constituted for a fixed term is automatically dissolved upon expiry of that term u/s 42 of Indian Partnership Act, 1932, unless partners explicitly agree that they want to continue partnership. In such a case, the partners may continue the business by entering into a new agreement or extending existing partnership arrangement.
Where a partnership isn’t dissolved automatically, it can be dissolved through different methods depending on the circumstances and the terms agreed between the partners. Some of the common methods are discussed below:-
Dissolving a partnership firm through mutual consent is perhaps the easiest and the most coherent way to dissolve such a firm. This form of dissolution is referred to as voluntary dissolution. The reason for it to be called voluntary is that the partners mutually agree that the partnership has run its course or it’s time for the partnership to end.
Under the Indian Partnership Act, 1932, a firm may be dissolved with the consent of all the partners or in accordance with a contract between the partners. The partners may record the terms of dissolution in a partnership dissolution agreement. This agreement may include the following terms:-
The date when the company was established.
The profits that the firm has made till now.
The division of profits after the dissolution of the partnership.
The date of dissolving the firm.
The reason for the dissolution.
Mutual consent clause of dissolution.
The formulated agreement should have the signatures of all the partners. This method works best when all the partners are in agreement about closing the firm and settling its affairs.
The chances that all the partners will agree to close the firm are quite slim. However, in the case of a partnership at will, any one of the partners can initiate dissolution by giving a written notice to all the other partners of their intention to dissolve the firm. The notice is given to the other partners and is not simply a notice filed with the Registrar of Partnerships.
The dissolution takes effect from the date mentioned in the notice or, if no date is mentioned, from the date of communication of the notice. While it might appear to be a simpler way to dissolve a partnership business, it is truly not. When there is discord between the partners, the chances of this notice being challenged are also high. Therefore, one should always be ready with a legal team because one can foresee the challenge happening.
There are certain circumstances specified under the law or partnership deed that can result in the dissolution of a partnership firm. This is referred to as dissolution on the happening of certain contingencies. The circumstances can include:-
The partnership was formed for a fixed term and that term has expired.
The partnership was formed to complete a particular undertaking and that undertaking has been completed.
The death of a partner, subject to any agreement between the partners.
A partner being adjudicated insolvent, subject to the provisions of the law and partnership agreement.
Therefore, exact effect of these circumstances can depend on terms agreed between partners in partnership deed.
Compulsory dissolution of a partnership firm happens in certain circumstances specified under the Indian Partnership Act, 1932. It does not mean every dissolution ordered by a court.
The law provides for compulsory dissolution in cases where all the partners, or all except one partner, are adjudicated insolvent, or when an event occurs that makes it unlawful for the business of the firm to be carried on. In such cases, the firm is compulsorily dissolved because it can no longer legally continue its business.
There are also situations where a partner can approach court for dissolution of firm. The court may dissolve firm on grounds such as:-
Mental Incapacitation:- If a partner has become of unsound mind, other partner(s) may seek dissolution of firm through court.
Incapacity:- If a partner, other than partner suing, has become permanently incapable of performing their duties as a partner, the court may dissolve firm.
Misconduct:- Where a partner has been guilty of conduct that is likely to affect the carrying on of business prejudicially, the court may order to dissolve firm.
Persistent Breach:- If a partner wilfully or persistently breaches agreements relating to management of firm or conducts themselves in a way that makes it impracticable for other partners to continue business, the court may dissolve the firm.
Business Cannot Continue:- If the business of firm can only be carried on at a loss, the court may dissolve firm. The court may also dissolve firm on other grounds where it considers it just and equitable to do so.
The accounts of a partnership firm are settled in the following way:-
Treatment of Losses & Capital Deficiencies:- The losses of the firm will first be paid out of the profits. If the losses are still not fully covered, they will be paid out of the partners' capital. If any loss still remains, the partners will contribute towards it individually according to their profit-sharing ratio.
Application of Assets (Order of Priority):- After this, the assets of the firm will be used in the following order:
First, the debts owed to third parties will be paid.
Any loans/advances given by partners to firm will then be repaid.
The capital contributed by partners will then be repaid.
Any amount left after making these payments will be distributed among the partners according to their profit-sharing ratio.
The firm's assets may be sold as part of the dissolution process and the money received from the sale is used to clear the firm's outstanding liabilities and settle the amounts due to the partners.
Also Read: Amalgamation of Partnership Firms
Dissolution of a partnership can take place through mutual agreement, certain contingencies, notice in the case of a partnership at will, compulsory dissolution or an order of the court. Once firm is dissolved, its assets and liabilities are settled. Any remaining amount is distributed among the partners according to applicable agreement and law. Also, where a partner has paid a premium to enter into a partnership for a fixed term and partnership is dissolved before expiry of that term, the partner may be entitled to repayment of premium or a reasonable part of it, subject to conditions and exceptions provided under the law.
Q1. Can a partnership firm get dissolved automatically?
A. Yes, a partnership firm can be dissolved automatically in certain situations. For example, u/s of Indian Partnership Act, 1932, a firm formed for a fixed period is generally dissolved when that period comes to an end.
Q2. How to close a partnership firm?
A. A partnership can be closed by methods like mutual consent, notice in case of partnership at will, certain contingencies, compulsory dissolution or through court order, depending on exact circumstances.
Q3. What happens if a partner of a partnership firm passes away?
A. When a partner of a partnership firm passes away, the existing partnership comes to an end. However, the firm may continue its business if there are other partners who can carry on business or if partnership deed contains a clause allowing firm to continue after demise of a partner.
Sunny Goel is a Chartered Accountant (CA) and the Senior Finance & Regulatory Consultant at Registrationwala. He has expertise in accounting, taxation, finance, regulatory compliance, and insurance compliance. He writes simple and easy-to-understand content to help businesses understand financial rules, tax laws, insurance regulations, compliance requirements, and other regulatory matters.
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