What is meant by the Dissolution of a Partnership Firm?

Dissolving a partnership firm legally means stopping the business under the name of the said partnership firm. In such a case, all liabilities are ultimately settled by selling off assets. Assets may be transferred to a particular partner, which settles all accounts that existed with the partnership firm.

Transfer of any profit/ loss to partners takes place according to their profit-sharing ratio which is agreed by them in the partnership deed.

Dissolving a partnership firm is different from dissolving a partnership. In the case of dissolving a partnership firm, the firm ends its name and hence cannot do business in the future. But in the case of dissolving a partnership, only the existing partnership is removed by consent or on happening of a certain event, but the firm can continue its operations if the remaining partners enter into a new partnership agreement.

Partnerships are a popular business tactic as it offers scope for more than one individual to contribute and take part in the business process. When the conditions become conducive, partnership firms are found to be a very friendly way to conduct business. That is why everyone should be knowledgeable about partnership businesses as well as the matters related to the dissolution of partnership firms.

Ways of Dissolving a Partnership Firm

A partnership firm may get dissolved in numerous manners. They are –

When Partners Mutually Agree

When all partners mutually agree upon closing the partnership firm, it may get dissolved. Partners can either give mutual consent or they may enter into an agreement for dissolution. It is the easiest way to dissolve a partnership firm.

Compulsory Dissolution

A firm may need to be dissolved compulsorily if −

• All partners are partners but one is declared insolvent.
• The firm is carrying out illegal or unlawful activities like dealing in drugs or other illegal products. They may get dissolved due to doing business with countries that may harm the interests of India or doing other such activities. These countries may include alien countries too.

Dissolution depends on Certain Contingent Events

Upon the occurrence of certain events, a firm may be required to get dissolved −

• Expiry of fixed-term – A partnership that is formed for a fixed tenure will get dissolved once the tenure ends.
• Completion of a task – Sometimes, a partnership may be formed for a certain goal or objective. Once the goal is reached, the partnership will automatically get dissolved.
• Death of the partner – In the case of only a two-partners partnership firm, if one of the partners dies, the partnership firm will automatically dissolve. However, when there are more than two partners, the business may continue to operate. In such a case, only the partnership will be dissolved. Other partners will enter into a new agreement and carry on the business.

Dissolution by Notice

If a partnership business is operating at will, the partnership firm may be dissolved by advance notice from any partner. The notice will contain a date till which the company will exist and after which the company will be dissolved.

Dissolution by Court

To dissolve a firm, the other partner(s) may file a case in court if any of the partners becomes mentally unstable or he/she misbehaves with the other partner(s) or doesn’t abide by the clauses of the agreement. But the court can dissolve the firm only when it is registered with the Registrar of Firms. Hence the court cannot dissolve unregistered firms.

Transfer of Interest or Equity to the Third Party

If control in the form of interest or equity is transferred to a third party without consulting other partners, the partner(s) may dissolve the firm.

Partners Still Liable to Third Parties

The partners are liable for any act done by any one partner which would have been an act of the firm if it was done before dissolution.

If a partner has retired from the firm or been declared insolvent, he will not be liable for any acts done after retirement or insolvency. The legal heirs of the partner who has died are also not liable for any acts initiated or done by other partners after the partner has died.

How are Accounts Settled?

Accounts of the firm are settled in the following order −

• Losses of the firm will be paid first. Losses are paid out of the profits, next out of the capital of the partners. If losses aren’t paid off even then, the losses will be distributed among the partners in profit-sharing ratios.
• The capital invested by the partners to set off losses of the firm and assets of the firm will be applied in the following order
  • Third-party debts must be paid first.
  • Next, if any loan has been taken from any partner it will be repaid to that partner.
  • Capital invested by each partner will be paid back to them in the capital contribution ratio.
  • The Balance amount of profit will be shared among the partners in the profit-sharing ratios.
  • Upon realization, the assets of the firm will be sold off in the market, and the proceeds met out of such a sale will be used for paying the liabilities. Assets or liabilities may be acquired by the partner(s) for which the respective partner capital accounts will be adjusted by the given amount.

Premium to be Returned on Premature Dissolution

If a partner has paid a premium to enter into a partnership for a fixed term, and the firm gets dissolved before the end of that given term, the firm should pay back the partner his premium amount. But few conditions are attached to this −

• The firm must not be dissolved due to the death of a partner.
• The Dissolution should not occur due to his misconduct.
• Dissolution is happening depending on an agreement that has no provision for repayment of a part or full payment of the premium.

Conclusion

As mentioned in the tutorial here, it must be noted that the dissolution of a partnership firm is different from the dissolution of a partnership. In the former case, the entire business stops working while in the latter case, only one or more partners retire from the business.

In the case of dissolution of a partnership firm, after the dissolution, it cannot continue the business, but a firm that had met a dissolution of partnership may carry on the business with a new contract.

The notable fact is that dissolution of partnership firms is often undesirable. Therefore, partnership firms try their best to abide by the rules and maintain goodwill among the partners. However, many partnership firms still split due to numerous reasons. The partners of firms must therefore be aware of their duties and responsibilities while carrying on a partnership firm.

FAQs

Q1. Name two contingent events on which the dissolution of partnership firms may rely.

Ans. The two contingent events on which the dissolution of partnership firms may rely include:

• Expiry of fixed-term, and
• Death of a partner

Q2. Give two conditions of Premium to be returned on premature dissolution.

Ans. The premium has to be repaid on premature dissolutions unless −

• The firm must not be dissolved due to the death of a partner.
• The Dissolution should not occur due to his misconduct.

Q3. Can mental instability be a matter of a partnership firm’s dissolution?

Ans. Yes. The mental instability of one partner may be the reason for the dissolution of a partnership firm.