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Partnership Firm

How Do You Dissolve A Partnership Firm?

The dissolution of a partnership firm is different from the dissolution of partners. In the dissolution of a firm, the partners stop all the business activities within the firm. This article will tell you the difference 

A partnership is a relationship between two or more individuals who have agreed to run a business together and share the profit equally. The number of partners in a firm can range between 2 to 20. Partnership firms are regulated by the Indian Partnership Act, 1932. The Partnership Agreement Act defines the rights and duties of the partners of a firm, as provided by Indian law. The dissolution of the firm leads to the dissolution of the partnership too.

Documents Required for Partnership Firm Registration

  • Form Number 1
  • Original copy of partnership deed
  • Rental or lease agreement of property where business is set
  • Affidavit declaring the intention of becoming a partner 

What Is Dissolution?

Dissolution refers to the end of the legal or contractual relationships between the partners in a business. Section 39 of the Indian Partnership Act states: “The dissolution of a partnership between all the partners of a firm is called the dissolution of the firm”. 

The Act defines the conclusion or complete breakdown of the partnership relationship. The question of dissolution arises due to either the death of a partner, retirement or if any of the partners turn insolvent.

Dissolution of Partnership Firm Vs Dissolution of Partners

The dissolution of a partnership firm is different from the dissolution of partners. In the dissolution of a firm, the partners stop all the business activities within the firm. At the time of the dissolution of the firm, the assets are used to repay the debt. The dissolution of partnership refers to the termination of all legal and contractual ties between the partners of a firm. This can happen when one of the partners retires and the other partners continue to run the business.

partnership firm registration online

According to the Indian Partnership Act, 1932, the dissolution of a partnership can take place in many ways mentioned in Sections 40, 41, 42, 43, and 44. The dissolution of partnership also can be done without the intervention of the court, as mentioned in Sections 40, 41, 42, and 43.

Consequences of a Dissolution of a Partnership

  1. The dissolution ends the partnership ties between partners
  2. It changes the dynamics of the mutual relations of the partners
  3. The dissolution of Partnership doesn’t end the relations or the business of the firm
  4. It doesn’t necessarily lead to the existence of the firm as a different entity
  5. Though one of the partners who leave gets discharged, the assets and liabilities of the firm remain unchanged.

When Can Dissolution Take Place?

The partnership firm can be terminated by mutual agreement without the intervention of the court by:

  • Dissolution by mutual consent of all partners (Section 40)
  • Compulsory dissolution due to any unlawful business activities (Section 41)
  • Dissolution due to contingent events like the death of a partner or adjudication of a partner as insolvent (Section 42)
  •  Dissolution by notice of partnership at will (Section 43).

The firm also can be dissolved by the intervention of the court. The Indian Partnership Act, 1932 empowers the court to effectuate the dissolution of a firm in several circumstances. The following conditions can invoke the power of the court to dissolve a firm, as per Section 44.

1. Partner of unsound mind

If it comes to the notice of the court that a partner of the firm is of unsound mind, then legal actions will be taken to dissolve such firm. Otherwise, if one or more partners have been declared mentally unsound or unstable, the court can initiate the dissolution process. However, mental instability is not an absolute ground for dissolution. Moreover, it is not always necessary that the state of instability is a permanent one. Therefore, it can be effectuated only with the consent of the other partners. Other similar circumstances like the character or the nature of the partner’s involvement are also considered to be a ground for dissolution.

2. Incapability or misconduct of the partner

Incapacity of a partner is when he/she becomes temporarily or permanently unable to discharge his duties as a partner of the firm. If the partner ignores the agreements and performs an illegal or unethical activity, then the dissolution of the partnership can be done on the grounds of professional misconduct. If the partner’s behaviour is not professional or ethical, then the required action will be taken. A partner can be charged with professional misconduct when his ill actions cause harm to the firm.

3. Breach of agreements

The partnership can be dissolved if the partner has breached the agreements that are related to the management of business affairs. The dissolution of a partnership also can be done when a partner indulges in any other illegal or unethical business activities.

4. Transfer of shares

If the partner other than the suing partner has transferred or sold his rights and shares to a third party, then the other partners can file for dissolution of the firm, according to Section 44 of the Indian Partnership Act.

5. Runs on losses

Any business is susceptible to face losses due to unforeseen circumstances. In such cases, the court can choose to dissolve the firm that can no longer churn profits. 

6. Other justifiable causes

If the court finds any other justifiable and equitable reasons apart from the ones mentioned above, then it has the right to issue an order to dissolve the partnership or the firm itself.

Settlement of Accounts on Dissolution

 Section 48 of the Indian Partnership Act, 1932: gives details regarding the settlement of accounts after the dissolution of such a firm. According to section 48, the following rules are to be followed:

  • Losses and deficiencies of the firm must be paid out of,
    • Profit amount
    • Capital amount 
    • The proportions in which the partners were entitled to share profits (if necessary)
  • Assets of the firm must be distributed in the following order:
  • In paying debts of the firm to the third parties
  • For paying the firm’s dues to each partner, for advances distinguishable from the capital amount
  • In paying each partner the due amount on account of the capital.

The surplus assets must be distributed among the partners in the proportion they were entitled to share the profits.

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