A partnership firm is said to be dissolved when it ceases to carry on business, its assets are sold and its liabilities are paid off. The firm discontinues its activities and none of the partners has any relation of partnership with other partners.
Dissolution of the firm should be differentiated from dissolution of partnership. In dissolution of partnership the original partnership agreement is terminated due to the admission, insolvency, retirement or death of a partner.
But the other partners continue the business by entering into a new agreement. A partnership can be dissolved without dissolving the firm.
Dissolution of partnership implies change in partnership whereas dissolution of firm means discontinuance of business. The dissolution of firm includes dissolution of partnership too.
A partnership firm may be dissolved in any of the following ways:
1. Dissolution by agreement:
A partnership firm may be dissolved with the mutual consent of all the partners or in accordance with the terms of the agreement.
2. Dissolution by notice:
In case of partnership-at-will, a firm may be dissolved if any partner gives a notice in writing to other partners indicating his intention to dissolve the firm.
In such a case, the dissolution takes place with effect from the date mentioned in the notice. If no date is mentioned, the firm would be dissolved with effect from the date of receipt of the notice by other partners.
When such a notice is given to other partners, it cannot be withdrawn without their consent.
3. Contingent dissolution:
A firm may be dissolved on the happening of any of the following contingencies:
(i) On the expiry of the term, if it is for a fixed period.
(ii) On the completion of the venture for which the firm was constituted.
(iii) On the death of a partner.
(iv) On the adjudication of a partner as insolvent.
4. Compulsory dissolution:
A firm stands automatically dissolved in the following cases:
(i) When all partners or all but one partner are declared insolvent.
(ii) When the business of the firm becomes unlawful due to the happening of an event.
5. Dissolution through Court:
Court may order the dissolution of a firm in the following cases:
(i) When a partner becomes of unsound mind.
(ii) When a partner becomes permanently incapable of performing his duties as a partner.
(iii) When a partner is guilty of misconduct which is likely to affect prejudicially (e.g. moral turpitude, misuse of money) the business of the firm.
(iv) When a partner willfully and persistently commits breach of the partnership agreement.
(v) When a partner unauthorized transfers the whole of his interest or share in the firm to a third person.
(vi) When the business of the firm cannot be carried on except at a loss.
(vii) When in the opinion of the court it is just and equitable that the firm should be dissolved.
Settlement of Accounts on Dissolution
When a partnership firm is dissolved, its assets are disposed of and the proceeds there from are utilised in paying the creditors.
If the amount realised by sale of assets is not sufficient to discharge the claims of the creditors in full, the deficiency can be recovered proportionately from the personal properties of the partners.
If any partner becomes insolvent, the remaining solvent partners will bear the loss in their capital ratio.
In case the assets of the firm are more than sufficient to meet the liabilities in full, then the surplus may be utilised to pay off the loans and capitals contributed by the partners.
Section 48 of the Partnership Act, 1932 lays down the following procedure for the settlement of accounts between partners after the dissolution of the firm:
1. Losses including deficiencies of capital should be made good (a) first out of profits, (b) then out of capital, and (c) if need be out of personal contributions of partners in their profit- sharing ratio.
2. The assets of the firm including any sum contributed by partners to make up deficiencies of capital will be applied for settling the debts of the firm, in the following order, subject to any agreement to the contrary
(i) First, in paying off the debts of the firm due to third parties;
(ii) Then in paying to each partner ratably any advances or loans given by him in addition to or apart from his capital contribution;
(iii) If any surplus is available after discharging the above liabilities, the capital contributed by the partners may be returned, if possible, in full or otherwise ratably;
(iv) The surplus, if any, shall be divided among the partners in their profit-sharing ratio.
Merits of Partnership
The partnership form of business organisation enjoys the following advantages:
1. Ease of formation:
Partnership is simple to form, inexpensive to establish and easy to operate, No legal formalities are involved and no formal documents are to be prepared.
Only an agreement between two or more persons to carry on a lawful business is required. Even the registration of the firm is not compulsory. Similarly, a partnership can be dissolved easily at any time.
2. Larger financial resources:
It is possible to collect a large amount of capital due to a number of partners. New partners can be admitted to raise further capital whenever necessary. Credit-worthiness is also high because every partner is jointly and severally liable for all the debts of the firm.
3. Combined abilities and judgement:
The skill and experience of all the partners are pooled together. Combined judgement of several persons helps to reduce errors of judgement.
The partners may be assigned duties according to their talent. Therefore, benefits of specialisation are available. Partners meet frequently and can take prompt decisions.
4. Direct motivation:
Ownership and management of business are vested in the same persons. There is direct relationship between effort and reward. Every partner is motivated to work hard and to ensure the success of the firm. Losses are shared and there is diffusion of risk.
5. Close supervision:
Every partner is expected to take personal interest in the affairs of the business. Different partners can maintain personal contacts with employees and customers fear of unlimited liability makes the partners cautious and avoid reckless dealings. Management of partnership is cheaper when expert managers are not employed.
6. Flexibility of operations:
Partnership business is free from legal restrictions and Government control. Partners can make changes in the size of business, capital and managerial structure without any approval. The activities of partnership business can be adapted easily changing conditions in the market.
A partnership firm is not required to publish its annual accounts. Audit of accounts is not essential and no reports are to be filed with the Government authorities. Therefore, the affairs of a partnership business can easily be kept secret and confidential.
8. Protection of minority interest:
Management of partnership is democratic. Every partner has a right to be consulted and express his opinion.
All important decisions are taken with the mutual consent of all the partners. In case a partner is dissatisfied with the majority decisions, he can retire from the firm or give a notice for its dissolution.
Partnership encourages mutual cooperation and trust amongst people. Partners work in common for the benefit of all and do their level best to make the business prosperous. They can take more balanced decisions than one man.
10. Scope for expansion:
There are greater possibilities for expansion and growth of business. More partners can be taken in to meet the financial and managerial requirements of growing business.
Demerits of Partnership
A partnership suffers from the following limitations:
1. Limited Resources:
There is a limit to the maximum number of partners in a firm. Therefore, it is not possible to collect huge financial resources. Borrowing capacity of partners is also limited. A partnership firm may not provide the required technical and administrative skills. There may be lack of professional management.
2. Unlimited Liability:
Every partner is fully liable for the debts of partnership business. Fear of risk may restrict initiative and growth of business. Private properties of partners can also be taken up for business liabilities.
3. Uncertain Life:
Partnership business suffers from instability. Insolvency, insanity, retirement and death of a partner may cause an abrupt end to business. Any partner can give a notice for dissolution of partnership.
Lack of confidence, unity and harmony among partners may lead to delayed decisions and inefficiency. Chances of conflict are high because every partner has an equal right to take part in the management of the firm.
5. Risk of implied authority:
Every partner is an agent of the firm. A dishonest partner may cause a great loss to the firm. Other partners may suffer a heavy loss due to the dishonesty or negligence of one partner.
6. Restriction on transfer of interest:
A partner cannot transfer or assign his share in the firm to a third party without the consent of other partners. He has, therefore, to lose the liquidity of his investment.
7. Reduced public confidence:
A partnership firm does not enjoy high degree of public confidence and prestige. This is because it is free from legal formalities and Government restrictions. Its accounts are not published and public is not aware of exact position of the business.