Meaning

The problem of the sole proprietorship in financing and managing an expanding business resulted in creation of partnership form of organisation.

The Indian Partnership Act, 1932 defines partnership as “the relation between persons who have agreed to share the profit of the business carried on by all or any one of them acting for all.”

Features

  1. Two or more Members:

At least two members are required to start a partnership business. But the number of members should not exceed 50, as fixed by Central Government.

  1. Agreement (Partnership Deed):

To start a partnership business, there must be an agreement between all the persons. This agreement contains:

  1. the amount of capital contributed by each partner.
  2. profit or loss sharing ratio.
  3. salary or commission payable to the partners, if any.
  4. duration of business, if any.
  5. name and address of the partners and the firm.
  6. duties and powers of each partner.
  7. nature and place of business; and
  8. any other terms and conditions to run the business.

    3. Lawful Business:

The partners should always join hands to carry on lawful business. Smuggling, black marketing etc. together cannot be called partnership business in the eyes of law.

  1. Profit sharing:

The main objective of every partnership firm is sharing of profits of the business among the partners in the agreed ratio. In the absence of any agreement for the profit sharing, profit and loss should be shared equally among the partners.

  1. Unlimited Liability:

Like in case of the sole proprietor the liability of partners is also unlimited. It means, if the assets of the firm are insufficient to meet the liabilities, the personal property of any partner, can also be utilised to meet the firm’s liabilities.

  1. Voluntary Registration:

The registration of partnership firm is not compulsory. However, if the firm is not registered, it will be deprived of certain benefits, therefore, it is desirable to get it registered.

The effects of non-registration of partnership firm are:

  1. The firm cannot take any action in a court of law against any other party for settlement of claims.
  2. In case there is any dispute among partners, it is not possible to settle the settlement of claims, through a court of law.
  3. The firm cannot claim adjustments for amount payable to or receivable from any other party through a Court of law.

    7. Principal Agent Relationship:

All the partners of a firm are the joint owners of the business. They all have an equal right to actively participate in its management. Every partner has a right to act on behalf of the firm. While dealing with other parties in business transactions, a partner acts as an agent of the others and at the same time the others become the principal. So there always exists a principal agent relationship in every partnership firm.

  1. Continuity of Business:

A partnership firm comes to an end in the event of death, lunacy or bankruptcy of any partner. Otherwise also, it can discontinue its business at the will of the partners. At any time, they may take a decision to end their relationship.

Merits

  1. Ease of formation and closure:

A partnership firm can be formed easily by an agreement between the prospective partners whereby they agree to carry out the business of the firm and share risks. The registration of the firm is not compulsory. Closure of the firm is also an easy process.

  1. Balanced decision making:

The partners can manage different functions as per their areas of expertise. This not only reduces the burden of work on an individual partner but also leads to better judgments. As a result, decisions are likely to be more balanced.

  1. More funds:

It is possible to raise larger amount of funds as compared to a sole proprietor and undertake additional operations as In case of a partnership, the capital is contributed by a number of partners.

  1. Sharing of risks:

The risks involved as well as losses incurred in running a partnership firm are shared by all the partners. This reduces the anxiety, burden and stress on individual partners.

  1. Secrecy:

A partnership firm is not legally required to publish its accounts and submit its reports. Thus, it is able to maintain secrecy of its activities and policies.

Limitations

  1. Unlimited liability:

Partners can be held liable to repay debts even from their personal property in case the business assets are not sufficient to meet its debts. The liability of partners is both joint and several, that discourages the persons having large personal property to become partner.

  1. Limited resources:

There is a restriction on the number of partners, and hence contribution in terms of capital investment is usually not sufficient for large scale business. As a result, partnership firms find it difficult to expand business beyond a limit.

  1. Possibility of conflicts:

Decision making authority is shared by the partners. There can be difference of opinion among them leading to disputes. Because of agency relationship, decisions of one partner are binding on other partners. Thus, an unwise decision by someone can result in financial burden on all others.

  1. Lack of continuity:

Partnership can come to an end with the death, retirement, insolvency or lunacy of any partner making it unstable form of organisation. The remaining partners will have to enter into a fresh agreement to continue to run the business.

  1. Lack of public confidence:

A partnership firm is not legally required to publish its financial reports. It is difficult for any member of the public to ascertain the true financial status of a partnership firm leading to low confidence of the public in partnership.

Types of Partners

A partnership firm can have different types of partners with different roles and liabilities.

  1. Active partner:

An active partner is one who contributes capital, participates in the management of the firm, shares its profits and losses, and has unlimited liability. These partners take active part in managing the affairs of partnership firm.

  1. Sleeping or dormant partner:

Partners who do not take part in the day-to-day activities of the business are called sleeping partners. But he contributes capital to the firm, shares its profits and losses, and has unlimited liability like active partner.

  1. Secret partner:

A secret partner is one whose presence in the firm is unknown to the general public. Otherwise, he is like all other partners. He contributes to the capital of the firm, takes part in the management, shares its profits and losses, and has unlimited liability.

  1. Nominal partner:

A nominal partner is one who allows the use of his name by a firm, but does not contribute to its capital. He does not take active part in managing the firm, does not share its profit or losses but has unlimited liability.

  1. Partner by estoppel:

A person is considered a partner by estoppel if, through his own initiative, conduct or behaviour, he gives an impression to others that he is a partner of the firm. Such partners have unlimited liability even though they do not contribute capital or take part in its management.

  1. Partner by holding out:

A partner by ‘holding out’ is a person who though is not a partner in a firm but knowingly allows himself to be represented as a partner in a firm. They have unlimited liability for repayment of any debts extended to the firm on the basis of such representation. In case he wants to save himself from such a liability, he should immediately issue a denial, clarifying his position that he is not a partner in the firm. If he does not do so, he will be responsible to the third party for any such debts.

Types of Partnerships

Partnerships can be classified on the basis of two factors:

  1. Duration
  2. Liability.

On the basis of duration:

a) Partnership at will

This type of partnership exists at the will of the partners. can continue as long as the partners want and is terminated when any partner gives a notice of withdrawal from partnership to the firm.

b) Particular partnership

Partnership formed for the accomplishment of a particular project or an activity to be carried on for a specified time period is called particular partnership. It dissolves automatically when that purpose is fulfilled or when the time duration expires.

On the basis of liability:

a) Partnership with unlimited liability (General Partnership)

In general partnership:

  • The liability of partners is unlimited and joint.
  • The partners enjoy the right to participate in the management of the firm and the acts of partners are binding on each other as well as on the firm.
  • Registration of the firm is optional.
  • The existence of the firm is affected by the death, lunacy, insolvency or retirement of the partners.

b) Limited Partnership:

In limited partnership:

  • The liability of at least one partner is unlimited whereas the rest may have limited liability.
  • Such a partnership does not get terminated with the death, lunacy or insolvency of the limited partners.
  • The limited partners do not enjoy the right of management, and their acts do not bind the firm or the other partners.
  • Registration of such partnership is compulsory.

The permission to form partnership firms with limited liability has been granted after introduction of New Small Enterprise Policy in 1991, to enable the partnership firms to attract equity capital from friends and relatives of small-scale entrepreneurs who earlier hesitated to help, due to unlimited liability.

Partnership Deed

There is need of clear agreement with respect to the terms, conditions and all aspects concerning the partners to avoid any misunderstanding later among the partners.

This agreement can be oral or written.

Even though it is not essential to have a written agreement, it is advisable to have a written agreement as it constitutes evidence of the conditions agreed upon.

The written agreement which specifies the terms and conditions that govern the partnership is called the partnership deed.

Aspects/subject matter/contents of Partnership Deed:

  • Name of firm
  • Nature of business and location of business
  • Duration of business
  • Investment made by each partner
  • Distribution of profits and losses
  • Duties and obligations of the partners
  • Salaries and withdrawals of the partners
  • Terms governing admission, retirement and expulsion of a partner
  • Interest on capital and interest on drawings
  • Procedure for dissolution of the firm
  • Preparation of accounts and their auditing
  • Method of solving disputes (arbitration)

You can check the format actually used here.

Registration of Partnership Firm

Registration of a partnership firm means the entering of the firm’s name, along with the relevant prescribed particulars, in the Register of firms kept with the Registrar of Firms. It provides conclusive proof of the existence of a partnership firm.

It is optional for a partnership firm to get registered. In case a firm does not get registered, it is deprived of many benefits.

Consequences of non-registration of a firm:

(a) A partner of an unregistered firm cannot file a suit against the firm or other partners.

(b) The firm cannot file a suit against third parties.

(c) The firm cannot file a case against the partners.

So, it is advisable to get the firm registered.

According to the Indian Partnership Act 1932, the firm can be registered with the Registrar of firms of the state in which the firm is situated.

The registration can be at the time of formation or at any time during its existence.

Procedure of Registration of Firm:

  1. Submission of application in the prescribed form to the Registrar of firms. The application should contain the following particulars:
  • Name of the firm
  • Location of the firm
  • Names of other places where the firm carries on business
  • The date when each partner joined the firm
  • Names and addresses of the partners
  • Duration of partnership

This application should be signed by all the partners.

  1. Deposit of required fees with the Registrar of Firms.
  2. The Registrar after approval will make an entry in the register of firms and will subsequently issue a certificate of registration.

 

Check your understanding

Cooperative Society – Meaning, Merits and Demerits