How To Form A Partnership Firm
- What constitutes a partnership
- Agreement of partnership
- Test of partnership
- Partnership for an adventure
- Partnership an agency
- Period of partnership
- Rights and duties of partners
- Property of partnership
- Limits on Agency of partners
- Retirement of a partner
- Types of partnership
- Partnership under Companies Act
- Partnership under Income Tax Act
- Partnership and other bodies of Individuals
- Limited partnership
- Stamp Duty and Registration
- Deeds and Agreements
A Partnership is defined by the Indian Partnership Act, 1932, as ‘the relation between persons who have agreed to share profits of the business carried on by all or any of them acting for all’. This definition gives three minimum requirements to constitute a partnership, viz. (1) there must be an agreement entered into orally or in writing by the persons who desire to form a partnership, (2) the object of the agreement must be to share the profits of business intended to be carried on by the partnership, and (3) the business must be carried on by all the partners or by any of them acting for all of them. The term ‘person’ is not defined by the Partnership Act. Section 2(42) of the General Clauses Act defines ‘a person’ to include a company or an association or body of individuals, whether incorporated or not. But the Supreme Court has held that this definition cannot be imported into the Partnership Act, and the ‘person’ under the Partnership Act means either an individual or any other legal entity such as a Limited Company registered under the Companies Act, or any other Corporation constituted by or under any act of the Legislature as a body corporate. The Supreme Court has observed that it is now well settled that Hindu Undivided Family cannot as such enter into a contract of partnership with another person or persons because it is a fleeting body, its composition changes by births and deaths, marriages and divorces and such a partner- ship is likely to have a precarious existence. It, therefore, follows that a body of individuals such as an unincorporated society cannot as such become a partner in a firm. It also follows that a partnership firm cannot as such enter into a partnership with another individual or legal entity, or with any other partnership firm because a partnership as such is not a .person. But in the case of H.U.F. the Karta of the family or a member thereof can become partner with another individual or with other legal entity or even with the partners or partner of a partnership firm because in such a case It is the Karta or the individual member who is the partner for all purposes and not the joint family whom he represents and the family does not become a partner of the firm. It has been held that when two Kartas of two H.U.Fs. enter into a partnership agreement, the partnership though popularly known as one between the two HUFs, in the eye of law, it is a partnership between two Kartas and the other members of the two families do not ‘ipso facto’ become partners. There is nothing to prevent individual members of one H. U. F. from entering into a partnership with the individual members of another H.U.F. and in such a case it is the partnership between the individual members and it is wholly inappropriate to describe such a partnership as one between two HUFs. When the Karta of a H.U.F. enters into a partnership with a stranger the members of the family do not ipso facto become partners in that firm and they have no right to take part in its management or to sue for its dissolution.
What constitutes a partnership
A firm is strictly not a person; It is an association of persons and the agreement by which a firm purports to enter into a partnership with an individual or another firm merely makes the partners of that firm individual partners of the larger partnership. A firm as such cannot enter into an agreement as a partner with another firm or individuals.
Therefore, when one partnership enters into a partnership agreement with another partnership firm, the partnership is in fact between all the partners of both the firms.
The Supreme Court has observed that a partnership agreement creates and defines the relation of partnership and, therefore, identifies the firm. if that conclusion is correct, it is only a further step to hold that each partnership agreement may constitute a distinct and separate partnership and, therefore, a distinct and separate firm.
That is not to say that a firm is a corporate entity or enjoys a juristic personality in that sense. The firm name is only a collective name for the individual partners and each partnership is a distinct relationship. The partners may be different and yet the nature of the business may be the same, the business may be different and yet the partnership may be the same. And agreement between partners to carry on a business and to share its profits may be followed by a separate agreement between the same partners to carry on another business and share the profits therein. The intention may be to constitute two separate partnerships and two distinct firms or to extend merely the partnership originally constituted to carry on one business or to carrying on another business. It will depend on the intention of the partners. The intention of the partners will have to be decided with reference to the terms of the agreement and all the surrounding circum- stances including evidence as to interlacing or interlocking of management, finance or other incidentals of the respective businesses.
In other words, the same partners can form two different partnerships. The Supreme Court has held that the word ‘person’ in section 4 of the Partnership Act contemplates only natural or artificial or legal person and a firm is not a person and as such not entitled to enter into a partnership with another firm or H. U. F. or individual. In this view of the matter there can arise no question of registration of a partnership purporting to be between three parties viz. a firm, a H.U.F. and an individual as a firm.
A partner in his individual capacity can legally be a partner in a firm and the fact that he has secured his capital from another firm or that he has entered into partnership with other members of that firm in respect of his share in the first mentioned firm does not show that the other firm is a partner of the first mentioned firm or that the latter firm is not validly constituted. A divided member or some of the divided members of an erstwhile joint Hindu family can enter into partnership with a third person, but under some arrangement inter-se between other members of the divided family but the partnership will have no concern with the obligations of such divided members to other members of their family in the partnership and their shares in the partnership have nothing to do with their shares In the Joint family’s divided properties.
Not only that but it has been held that the Karta of a H.U.F can enter into partnership with an individual member of that very family provided the member has contributed his own self acquired capital by way of money or other property to the capital of the firm. And the members personal skill and labour is held to be his property which can be a contribution to the capital of such a firm.’ Similarly if a benamidar, who has the character of a trustee of the real owner, enters into partnership with another in his own name the share allotted to him in the partnership must be held to specify his individual share therein.’ Shortly, therefore, the position is that partnership can be only between individuals and/or any other legal entity, and those who are actually parties to a partnership agreement will be considered as partners irrespective of their personal relationship with others inter-se and with which the partnerships will not be concerned, such as the beneficiaries if their trustee is a partner or the real owner If his benamidar is a partner or members of a HUF if their Karta is a partner or the partners of a firm if one of them is a partner of the other firm and so on.
Agreement of partnership
As stated above a partnership is constituted by an agreement between the partners. The agreement may be in writing or oral. But from the practical point of view and particularly in view of the provisions of other Acts such as the Income Tax Act as well as Partnership Act an oral partnership is not practicable, and therefore, a partnership agreement is necessarily required to be in writing.
Therefore, the mere fact that two persons as joint owners either as heirs or legatees are carrying on a business it does not necessarily mean that they are partners and if they want to carry on the business in partnership, then a Partnership agreement in writing becomes necessary. For example, if a person dies leaving a running business and his heirs continue to carry on such business, it will not be a business carried on in partnership and if they want to do so they will have to enter into a regular agreement of partnership.
Being an agreement and an agreement enforceable at law, such an agreement must fulfill the basic requirements of a valid contract, as required by the Contract Act. Therefore, a minor or a mentally handicapped person cannot enter into a partnership agreement though by virtue of the provisions of the Partnership Act a minor can be admitted only to the benefits of the partnership. But that only means that a minor can have a share in the profits of the business, but he cannot become a partner, and cannot execute any agreement of partnership.
Similarly if a partnership deed provides that on the death of a partner his heirs or any one or more of them should be admitted as partners or partner in place of the deceased partner even in such a case on the death of a partner his heirs or any of them do not become partners automatically on such death. But a fresh agreement of partnership will have to be executed between the existing partners and the heirs or heir of the deceased partner and if the heir is a minor the new partnership will stand postponed till the minor attains majority or if the surviving partners are more than one, the minor can only be admitted to the benefits of partnership.
Test of partnership
As stated before, a partnership agreement can be oral or in writing. It is not the general practice to enter into a preliminary agreement to enter into a regular partnership agreement. But if such a preliminary agreement is entered into and the partners start business in anticipation of executing a formal deed of partnership, the partnership shall be deemed to have commenced from the commencement of the business, unless the preliminary agreement is conditional upon the happening or not happening of some event in which case the partnership cannot be said to have come into existence unless the event has happened or not happened. Another test of partnership as mentioned above is that of sharing profits, and which is an essential requirement of a partnership. Profits may be shared in such proportions as the parties may agree, but sharing of profits is most essential. As against that, sharing of losses only suffered in business is not a test to constitute a partnership.
Therefore, the partnership agreement may provide that a particular partner or partners will not be liable to bear any losses of the firm. As regards sharing in profits the agreement may provide that a partner shall receive only a fixed share in the profits or a fixed periodical amount and It is not necessary that profits should be shared in certain proportions.
Section 6 of the Partnership Act provides that In determining whether a group of persons is or is not a firm or whether a person is or is not a partner in a firm regard shall be had to the real relation between the parties as shown by all the relevant facts taken together.
It further provides that sharing of profits or gross returns arising from property by persons holding joint or common interest in that property does not of itself make such persons partners, that is, as stated above, mere joint ownership of business does not constitute a partnership.
Similarly, receipt by a person of a share of the profits of a business or a payment contingent upon earning of profits or carrying with the profits earned by a business, does not of itself make him a partner with the person carrying on the business. For example, the receipt of a share or payment by a lender of money to persons engaged or about to engage in a business does not make such lender a partner.
Similarly, a share given in profits to a servant or agent as remuneration does not make him a partner, or if a widow or child of a deceased partner is given any annuity in payment of the share of the deceased partner It does not make the widow or child a partner, or if a business is sold with goodwill and the seller is given a share in profits towards payment of the sale price it will not make him a partner of the firm. But otherwise wherever the agreement is for sharing of business carried on by two or more persons the partnership relation will be inferred.
The partnership business may consist of doing anything which is not illegal or against public policy. Business may consist of carrying a continuous trade. or profession or any manufacture and any other activity of which the object is to earn profits. Or it may be limited to a single adventure.
Partnership for an adventure
Section 8 of the Partnership Act provides that a person may become a partner with another partner In particular adventure or undertaking.
As observed by the Gujarat High Court, the common law does not recognise the relationship of co-adventurers but with the passage of time, the judicial decisions have recognised what is known, as joint ventures of two or more persons undertaking to combine their property or labour in context of a particular line of trade or general business for joint profits. The courts do not treat a joint adventure as identical with the partnership though it is so similar in nature, and in the contractual relations created between such adventurers the rights as between them are governed particularly by the same rules that govern the partnership.
This relationship has been defined to be a special combination of persons undertaking jointly some specific adventure for profit without any actual partnership.
It is also described as a commercial or maritime enterprise undertaken by several persons jointly, a limited partnership, not limited in the statutory sense as to the liabilities of the partners, but as to its scope or duration. Generally speaking the distinction between joint venture and partnership is that former relates to a single transaction though It may comprehend business to be continued over several years while the latter relates to a joint business of a particular trade. In order to constitute a joint venture there must be a community of interest and right tojoint control.
It is recognised on authority that each of the partners must have equal voice in the matter of performance and control over the activities used therein though one authority may entrust the performance to another.
The rights and duties and liabilities of a joint venture are similar or analogous to those which govern corresponding rights and duties and liabilities of the partners. The only difference between partnership under section 8 of the Partnership Act and an ordinary partnership is that ln joint venture, parties undertake no liability beyond the limit of a particular venture/adventure or business or undertaking and their rights and obligations are, therefore, less extensive than those of the partners in ordinary partnership.
Partnership an agency
The third essential of a partnership is that a partnership business actually may be carried on by all the partners together or by any one or more partners for all and on behalf of the others, in which case each partner is an implied agent of the other partners. It is not. therefore, necessary that all the partners take part in the business of the partnership firm. Some partners can be active partners and others can be sleeping partners. But it must be clear that there is an implied or express agency constituted in favour of one partner by the other partners. If there is no element of agency, even if there is any agreement to share profits, there will be no partnership. So a partner has a double capacity, he is the principal so far as he is concerned and the agent so far as other partners are concerned.
Period of partnership
A partnership can be for a fixed period of time or it may be limited to a particular adventure as provided in Section 8 or it may be for a duration at the will of the partners. Where the period of the partnership is not fixed and the partnership is not for a particular adventure then under section 7 of the Act the partnership shall be deemed to be a partnership at will.
Rights and duties of partners
Sections 9 & 10 of the Act lay down the basic duties of every partner and the said duties are not subject to any contract to the contrary. Therefore, partners are bound to carry on the business of the firm to the greatest common advantage, to be just and faithful to each other and to render accounts and full information of all things affecting the firm to any partner or his legal representative and every partner is bound to indemnify the firm for any loss caused to it by fraud in the conduct of the business of the firm.
Subject to this the mutual rights and duties of partners may be decided by contract between the partners, either express or implied.
Subject to any contract to the contrary such duties and rights of each partner are provided in Sections12 and 13 of the Partnership Act.
|every partner has a right to take part in the conduct of the business,|
|every partner is bound to attend diligently to his duties in the conduct of business.|
|any difference arising as to ordinary matters connected with the business may be decided by a majority of partners and no change in the nature of the business shall be made without the consent of all the partners,|
|every partner has a right to have access to and to inspect and copy any books of the firm|
|a partner is not entitled to receive remuneration for taking part in the conduct of the business,|
|the partners are entitled to share equally in the profits earned and shall contribute equally to the losses sustained by the firm,|
|where the partner is entitled to interest on the capital subscribed by him, such interest shall be payable only out of the profits a partnership making, for the purpose of the business, any payment or advance beyond the amount of capital he has agreed to subscribe, is entitled to Interest thereon at the rate of 6% per annum.|
|the firm shall indemnify a partner in respect of payments made and liabilities incurred by him,|
|the partner shall indemnify the firm from any loss caused due to his wilful neglect in the conduct of the business of the firm.|
These rights and duties will be implied in the partnership unless the partnership agreement provides to the contrary i.e. makes any variation in the said rights and duties.
Similarly, subject to a contract to the contrary, if a partner derives any profit for himself from any transaction of the firm or from the use of the property or business connection with the firm or the firm name he is liable to account for the profit and pay it to the firm, and if the partner carries a business of the same nature as and competing with that of the firm, he shall account for and pay to the firm all profits made by him in that business.
Property of partnership
The property of a partnership firm will consist of all the assets, moveable and immoveable brought in by any or all the partners into the firm and also include the goodwill.
As to what is goodwill see Introductory Note to Ch. 3 Part III. It may be stated that relying upon the specific provision of s. 22 of the English Partnership Act, 1890, the Supreme Court has held that all property of a partnership firm, whether moveable or immoveable is moveable property. and therefore, on retirement of any partner or dissolution of partnership the division of even immoveable property among the partners does not amount to transfer of property and the deed of retirement or dissolution does not require registration.
The Supreme Court has not considered the law of vesting and divesting of interest in an immoveable property. A property acquired by A by purchase or otherwise is vested in him and even if A brings that property into partnership and it is used for the partnership business, the property is not automatically divested from A and vested in A and his other partners.
Vesting and divesting can take effect only by act of parties or by operation of law, and, therefore, the property brought in by A cannot become vested in the other partners unless there is a regular transfer of the property by A to himself and other partners. And similarly if property vested in the partners is divided, among them, it amounts to transfer of one partner’s interest to the other, and such transfer is necessary to vest and divest the title from one to the other.
Even in English law, in spite of the provisions of Partnership Act above referred to, the convincing practice is to effect the transfer of property brought in or taken out of the partnership by a Deed of Conveyance.
Limits on Agency of partners
As stated above, every partner is an agent of the other partners and has implied authority to do all acts and things necessary for the purpose of carrying on business of the firm. But such an implied authority does not empower a partner to
(a) Submit a dispute relating to the business of the firm to arbitration or
(b) open a banking account on behalf of the firm in his own name,
(c) compromise or relinquish any claim or a portion of a claim by the firm,
(d) withdraw a suit or proceeding on behalf of the firm,
(e) admit any liability in a suit or proceeding against the firm,
(f) acquire immoveable property on behalf of the firm,
(g) transfer any such property, or
(h) enter into any partnership on behalf of the firm.
These being the implied authorities they can be modified by express provisions in the partnership deed.
As stated above, the partnership is not a legal entity by itself, but only an association of persons and the name of the firm is only a mode or compendious expression representing the partners. However, section 22 of the Act provides that in order to bind a firm, an act or instrument done or executed by a partner or other person on behalf of the firm shall be done or executed in the firm name or in any other manner expressing or implying the Intention to bind the firm. This means that in order to bind the firm and all the partners thereof every act must be done in the name of the firm or expressly on behalf of the Firm. Therefore, when a contract is entered into for and on behalf of a partnership firm. It is desirable to make the firm by its one or more partners as a party or one or more partners can be made a party in his or their names but as partners of their firm. A mere description of the signatory that he is partner of a firm may not be sufficient to bind the firm. But here a distinction should be made between an ordinary contract and a deed of transfer of any immoveable property. In a case where an immoveable property is to be acquired by purchase or lease or otherwise, it is necessary to make all or some of the partners as parties and not the firm in its name. A firm is not a legal person and a transfer can be only by or in favour of a legal or juridical person as provided in S. 5 of the Transfer of Property Act. A partnership firm by its name is not a juristic person like a corporate body. It is the partners who are as a body of persons juristic persons .
It is not necessary to deal with the provisions of the Partnership Act contained in sections 20 to 30 as they are not relevant so far as drafting of a deed of partnership and other incidental documents, is concerned. Those provisions are also binding upon any firm as they are not subject to contract to the contrary
Retirement of a partner
|Under the Partnership Act no person can be admitted into partnership without the consent of the other partner or partners unless there is any contract to the contrary (S. 31).|
|Any partner may. with the consent of all the other partners or in terms of the deed of partnership where the partnership is at will, by giving notice in writing to all other partners, to that effect, dissolve the partnership or retire from partnership.|
|A retiring partner, however, continues to be liable to third parties even If the liability Is taken over by the remaining partners (S.32). Therefore in a deed of retirement it is necessary to provide that In the event of the retiring partner being held liable by a third party, the remaining partners shall indemnify him to that extent, when the liabilities are taken over by the remaining partners.|
|Insolvency of a partner also causes compulsory retirement of an insolvent partner (S. 35). It is, therefore, generally provided in a deed of partnership when there are more than two partners that the insolvency of any partner will not dissolve the partnership. If a partner retires, unless there is contract. to the contrary, the retiring partner cannot use the firm name, represent himself as carrying on the business of the firm or solicit the customers of the Firm. (S.36).|
|Therefore, in a deed of retirement It is generally not necessary to make explicit that the retiring partner shall not do any of these things. But if he is to be restrained from carrying on similar business for a specified period or in a specified area, such condition can be provided in the deed of retirement and it is legal (S.36(2)).|
The Act also provides that a partnership firm may be dissolved under the following circumstances namely,
|as a result of any agreement between all the partners|
|by adjudication of all the partners or all partners but one as insolvent, or|
|by the happening of an event which makes it unlawful for the business of the firm to be carried on in partnership or|
|subject to agreement between the parties,|
|efflux of time,|
|completion of the adventure,|
|death of a partner, and|
|insolvency of a partner.|
In these last four cases the partnership agreement may provide whether the firm will be dissolved or not on the happening of any of the four events. Even if the deed provides that the partnership will not be dissolved on the death or insolvency of a partner, it does not mean that on the death or insolvency of a partner he ceases to have interest in the partnership property. In such case his interest in the partnership property will survive to his heirs in case of his death and to his assignees in case of insolvency. In the absence of a term in the deed of partnership to that effect, it cannot be that, the partnership shall continue, and notwithstanding the death of a partner it will operate to extinguish his proprietary rights in the assets of the Firm.
A partnership can also be dissolved by the Court under the circumstances mentioned in Section 44 of the Act. Where the partnership is ‘at will’ the partnership can be dissolved by any partner or partners giving notice of his/their intention to dissolve the firm.
Types of partnership
The result of this summary of the Act is that a partnership is generally created by agreement between the partners. A partnership can be formed between
|one or more Individuals or|
|between an Individual and a person representing a H.U.F. or|
|between an Individual and other partner representing his firm, or|
|between two partnership firms or|
|between a Limited Company or a Corporation and an Individual or partnership firm or|
|between a partnership and a H.U.F.|
|between members of HUF in their individual and independent capacity|
|between a HUF and a member of that HUF independently.|
Partnership under Companies Act
Section 4 of the Companies Act, 1956, provides that the number of partners in a firm shall not exceed 20, and a partnership having more than 20 persons will be illegal.
When there is partnership between two firms all the partners of each firm will he taken into account for the purpose of this provision but if a partnership is between the Karta or any member of HUF on the one hand and another individual or Individuals on the other, the members of the joint family will not be taken into account. A Hindu Undivided family carrying on business as such, not being a partnership, S 11 of the Companies Act will not apply even if the members of that family are more than 20. But where two or more Hindu Undivided families are carrying on business in partnership the number of the members of those families except minors will be taken into account for the purpose of S. 11 of the Companies Act.
Partnership under Income Tax Act
A partnership to be recognised for the purpose of income Tax liability of the partners and their firm is required to comply with certain provisions of the Income Tax Act. While therefore drafting a deed of partnership the provisions of the Act are required to be taken in to account. For detail discussion on this question See Chapter 3 part VIII.
Partnership and other bodies of Individuals
A partnership is distinguishable from several other associations or bodies of individuals. A partnership is different from co-owners in several respects. The distinguishing features are stated by the Supreme Court in Champaran Cane Concern Corporation v. State of Bihar. It is different from a club which is an association of persons formed for the purpose other than carrying on business and therefore there is no object to earn profit. Partnership is differentfrom a company or any other corporate body which is a legal entity. Partnership is also different from Hindu Joint family firm, the latter being a creation of law while the former is a creation of contract. It is not necessary to discuss the subject in more detail as each of these bodies are dealt with separately elsewhere.
A partnership firm is required to he registered under sections 58 and 59 of the Partnership Act, though it is not compulsory.
Every change in the constitution of a partnership is also required to be registered. But if it is not registered, then there are certain handicaps stated in S.69 of the Act.
The main handicap being that a partnership firm or its partner cannot file a suit against a third party. In Maharashtra, the Section is made more stringent making registration almost compulsory. For the purpose of income tax benefits It is necessary to register a partnership with the Department under S. 184 and S.185 of the Income Tax Act, 1961. For the Influence of the Income Tax Act on partnership, see Ch. III in Part Viii.
The concept of limited partnership is not recognised by Indian Law. It is prevalent in England and America and other countries. In England, the limited partnership is governed by the Partnership Act of 1907. It consists of general partners who are the main partners with exclusive right of management and their liability is unlimited. But they can take any linilted partner who contributes some capital to the Firm and whose liability is limited to that amount provided he does not participate in the management or withdraw any part of the capital contributed by him during the term of partnership. However a limited partnership is not a separate legal entity like a limited company. Generally a limited partner joins a firm to participate in a particular scheme or adventure of the firm.
Stamp Duty and Registration
Stamp Duty : On a Deed of Partnership the stamp duty under the Indian Stamp Act is a fixed one. The same duty is payable on a deed of retirement or a deed of dissolution. But in Maharashtra, if the deed of retirement or deed of dissolution effects any transfer of an immoveable property, it will attract stamp duty as on a conveyance on the market value of the property. For the law in different States, see Ch.1 in Part VIII.
Registration : A partnership deed is not required to be registered even if an immoveable property is brought in the firm. Similarly, a deed of retirement or a deed of dissolution is not required to be registered. According to Supreme Court a division of even immoveable properties on dissolution is not required to be registered as it does not amount to a transfer. The correctness of this view is doubtful and it is desirable to get such a deed of dissolution or retirement registered for the sake of caution or safety.
Deeds and Agreements
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