Dissolution Of A Firm

Introduction

When the relationship between all the partners of the firm is terminated then it is called the dissolution of the firm. After the dissolution of the partnership firm, the firm won’t exist anymore. This dissolution process includes disposing and discarding of all the assets of the firm and/or settlements of accounts, assets, and liabilities.

What is Dissolution of Partnership Firm?

Dissolution of a firm or a partnership firm is a procedure in which the professional relationship between numerous partners of a firm is removed or terminated.

After the dissolution of a partnership firm, a change takes place in the existing relationship between the partners'. But, the firm carries on its activities.

The dissolution of a partnership firm may take place in any one of the following ways −

• By a change in the existing profit sharing ratio.

• By the admission of a new partner

• Due to the retirement of an existing partner

• Due to the death of an existing partner

• Due to the insolvency of a partner. Due to insolvency, the partner becomes incompetent to contract. Thus, he can no longer be a partner in the partnership firm.

• If a specific venture is formed, the partnership is formed specifically for that particular venture.

• On the completion of the time period up to which the partnership was formed.

Section 39 of the Indian Partnership Act 1932 defines that the dissolution of a partnership firm means dissolution among all the partners of the firm. The dissolution of a partnership firm finishes the existence of the firm. After the dissolution, the partnership firm cannot enter into any new contract or transaction with anybody. It can only sell its assets to get the amount, pay for the liabilities of the firm, and dissolve the claims of the partners. It is not mandatory to have court intervention for the dissolution of a firm.

It is notable that the dissolution of a partnership may not always result in the dissolution of the firm. It always means the dissolution of the partnership.

Furthermore, the dissolution of a partnership firm is often undesirable and may be a result of a mutual clash. Therefore, laws and rules regarding the dissolution of firms are very pertinent and wholesome in nature. In the case of dissolution, many discrepancies may take place which must be removed for a cleaner dissolution. That is why the legal tangles related to the dissolution of firms are so important.

Various Ways of Dissolution of Partnership Firm

Following are the ways in which the dissolution of a partnership firm takes place −

Dissolution by Agreement

A firm may get dissolved with the agreement of all the partners to the dissolution. Also, if there is a contract between the partners with respect to the dissolution, the dissolution may occur according to it.

Compulsory Dissolution

In the following cases the dissolution of a firm occurs on a compulsory basis −

In the case of insolvency of all the partners or, only one partner which makes him incompetent to enter into a contract.

When the operations turn illegal for some reason, dissolution of the firm may take place.

When it becomes unlawful for the partnership firm to carry out its business, the firm may be dissolved. For example, if a partner of the firm is from another country and India declares war against that country, then the partner becomes an enemy. The business with that partner becomes unlawful then.

Occurrence of Certain Contingencies

The dissolution of the firm takes place subject to a contract among the partners, if −

If the firm is formed to carry out a specific venture, on the completion of that venture the firm becomes dissolved.

If the firm is formed for a fixed term, it gets dissolved on the expiry of that term.

A partnership firm between two partners gets dissolved when a partner dies.

A partnership firm between two partners gets dissolved when a partner becomes insolvent.

Dissolution by Notice

If the partnership is at will, and if any one of the partners provides a notice in writing to the other partners stating his intention to dissolve the firm, then the dissolution of the firm may take place.

Dissolution by Court

When a partner files a lawsuit in court, the court may order the dissolution of the firm on the basis of the following grounds −

If a partner of the firm becomes insane.

When one of the partners becomes permanently unable to perform his duties.

If a partner is found guilty of misconduct and it hurts the firm’s business adversely.

When the partner continuously engages in breaches of the partnership agreement.

In the case when a partner transfers his ownership in the partnership firm to a third party.

In a case when the business can only be carried at a loss

When the court thinks the dissolution of the firm is lawful and equitable on many grounds.

Settlement of Accounts

In the case when the partnership firm does not have any agreement regarding the dissolution of the firm, the following provisions of the Indian Partnership Act 1932 will prevail −

Firstly, the firm will pay the losses including the deficiency of capital firstly out of the profits. Secondly, it will be paid out of the partner’s capital, and finally by the partners individually in their profit sharing ratio.

Firstly, the firm should use its assets including any contribution to make up for the deficiency by paying the third party debt. Secondly, any loan or advance by any partner must be paid. Finally, and lastly, the partners’ capital must be paid. Any surplus that is left after making all these payments is shared by partners in the profit-sharing ratio.

Conclusion

Sometimes, it is apparent that dissolution is the only way out for the settlement of disagreements among the partners of a firm. In such cases, the norms mentioned above are used to dissolve the firms. Such dissolution techniques help in reaching peaceful ends in the dissolution or dissolving of partnership needs.

The laws of dissolution of firms must be agreed upon via an agreement by partnership firms to avoid any legal intervention after the death or separation of one member of the partnership firm. To reach a settlement quickly, an agreement must be there to help partners decide the aftermath of dissolution quickly and correctly.

Finally, the partners of a firm must be aware of the norms of dissolution and their roles and rights in a partnership firm. This helps in the legal and equitable dissolution of firms which is a requirement for all partners of a firm. Partners of a firm should always abide by the partnership deed in order to keep the rules above everything else.

FAQs

Q1. Which law governs the settlement of accounts in the case of dissolution of a partnership firm?

Ans. Settlement of accounts after the dissolution of a firm is governed by the provisions included in the Indian Partnership Act, 1932.

Q2. Give two examples of cases when the dissolution of a partnership firm is made by the courts.

Ans. The dissolution of a partnership firm is made by the court when −

• One of the partners becomes permanently unable to perform his duties.

• A partner transfers his ownership in the partnership firm to a third party.

Q3. Can a firm enter into new contracts or do business after its dissolution?

Ans. No, firms cannot do business or get into new contracts after dissolution. They can just sell the assets.