Chapter 6: Partnership

A sole proprietor who wants to grow runs into two limits at almost the same moment: the capital one person can raise, and the range of skills one person can supply. A trader who knows buying and selling may have little grasp of accounts; a person with money to invest may have no time to stand in the shop. The obvious remedy is to bring a second person into the ownership of the business. Partnership is the form of organisation built on that remedy. Two or more persons agree to carry on a lawful business jointly, pool their capital and managerial ability, and share the profits in an agreed ratio. It is their agreement, and not any grant by the State, that creates the firm. The remedy solves one problem and raises others: who decides, who is answerable when the firm cannot pay, and what happens when one partner acts alone. This chapter explains the meaning and characteristics of partnership, its merits and demerits, the kinds of partners and of partnerships, the partnership deed, and the registration of a firm together with the consequences of not registering.

Figure

Fig. 6.0-1 — Two Owners Running A Small Firm Together Photograph of two owners of a small trading or retail business going through the account books together at the counter.

6.1 Meaning And Definitions Of Partnership

A partnership is a voluntary association of two or more persons who agree to carry on a lawful business jointly and to share its profits and losses. It comes into existence the moment such an agreement is made, whether that agreement is written or oral, and it exists only for as long as the persons concerned wish to continue it.

The persons who enter into this relation are individually called partners and collectively a firm. The name under which they carry on the business is the firm name. These are conveniences of speech rather than of law: the firm is not a person separate from the partners, and every reference to the firm is in substance a reference to the partners who compose it.

The relation of partnership arises out of contract and not out of status. Persons do not become partners because they are related to one another or because they have inherited a business together; they become partners because they have agreed to be. This single point separates partnership from a joint Hindu family business, where membership follows from birth into the family.

Definition

Partnership Under the Indian Partnership Act, 1932, partnership is the relation between persons who have agreed to share the profits of a business carried on by all of them or by any of them acting for all.

What The Definition Requires

The statutory definition is short, but each phrase in it fixes a condition that must be satisfied before a relation can be called a partnership.

An agreement between persons — there must be a contract, express or implied, between two or more persons who are competent to contract. Without agreement there is no partnership, however closely the persons may be associated in a business.
A business — the association must be formed to carry on some business. Two persons who merely own property jointly, or who come together for a charitable object, are not partners, because there is no business and no profit to share.
Sharing of profits — the persons must have agreed to share the profits of that business. Sharing of losses follows as a consequence of sharing profits, and need not be separately stated.
Business carried on by all or by any of them acting for all — the business may be run by every partner, or by one or a few on behalf of the rest. Whoever runs it does so as representative of all, and this is what binds the others to the acts done.

The fourth condition is the decisive one. A person may be given a share of profits as a reward for services or as interest on a loan without becoming a partner; what makes him a partner is the authority to act for the others and to bind them. Sharing of profits, therefore, is strong evidence of partnership but is not by itself conclusive proof of it.

Do Not Mix Up

Partnership And Firm Partnership is the relation created by the agreement between the persons. The firm is the collective name for those persons in that relation. The relation is the substance; the firm name is only the label under which the business is carried on.

Why The Form Was Adopted

Partnership grew out of the practical limits of sole proprietorship. Capital, managerial skill and business acumen seldom meet in one person, and a business that outgrows one owner needs both more funds and more hands. By admitting a second or third owner, the proprietor gains capital, shares the work and spreads the risk, while keeping the freedom from legal formality that a company does not enjoy.

Try Yourself

Find two firms near your home whose names include words such as ‘Brothers’, ‘and Sons’ or ‘and Company’, and note from their signboards whether more than one owner is named.

6.2 Essential Characteristics Of Partnership

The definition tells us when a partnership exists. Its characteristics tell us how the relation actually works once it has been formed — how the firm is created, who is bound by whose acts, and how far the owners can be pursued for what the business owes.

These characteristics fall into two groups. Some are laid down in the Indian Partnership Act, 1932 and cannot be altered by the partners; these are the statutory characteristics. Others follow from the nature of the relation itself and from ordinary business practice; these are the general characteristics. The grouping is set out in FC 6.1.

Flowchart

FC 6.1 — Characteristics Of Partnership Characteristics Of Partnership → Statutory, General; Statutory → Agreement between two or more persons, Lawful business, Contractual relationship, Profit motive, Principal-agent relationship; General → Unlimited liability, No separate legal entity, Utmost good faith, Restriction on transfer of interest, Definite firm name, Mutual agency, Registration optional, Only individuals as partners

6.2.1 Statutory Characteristics

Statutory characteristics are the conditions the law itself attaches to the relation. If any one of them is absent, the association is not a partnership at all, whatever the parties may choose to call it.

Agreement between two or more persons — a partnership needs at least two persons, since one person cannot contract with himself. The maximum number is fixed by the rules framed under the Companies Act, 2013, and at present stands at fifty. An association larger than the prescribed maximum must be registered as a company.
Lawful business — the business carried on must be legal. An arrangement to share the proceeds of smuggling or theft is not a partnership, because the law will not recognise an agreement whose object it forbids.
Contractual relationship — the relation springs from a contract, so only persons competent to contract may become partners. A minor or a person of unsound mind cannot enter into the contract, and therefore cannot be a partner, though a minor may be admitted to the benefits of the partnership.
Profit motive — the business must be carried on with the object of earning profit and the partners must have agreed to share it. Charitable trusts, free dispensaries and clubs are therefore outside the definition, however many persons manage them jointly.
Principal-agent relationship — each partner acts as an agent of the firm when he deals with outsiders, and as a principal when the other partners deal on his behalf. This dual role is what allows a firm to be run by one or two working partners without the rest signing every contract.

Definition

Mutual Agency Mutual agency means that every partner is both an agent of the firm and a principal for the other partners. An act done by one partner in the ordinary course of the firm’s business binds the firm and all the partners in it.

6.2.2 General Characteristics

General characteristics are not written into the Act as tests of existence, but they describe how a firm behaves in practice and they explain most of its merits and demerits.

Unlimited liability — every partner is liable jointly and severally for the debts of the firm. If the firm’s assets fall short, the private property of the partners can be used to satisfy creditors, and one partner may be made to pay the whole amount and then recover from the others.
No separate legal entity — the firm has no existence in law apart from its partners. It cannot own property or sue in its own right independently of them, and the partners remain personally answerable for whatever the firm does.
Utmost good faith — because each partner can bind the rest, the relation rests on trust. Partners are expected to act honestly, to render true accounts and to disclose anything material to the firm’s business, and not to make a secret profit from it.
Restriction on transfer of interest — a partner cannot transfer his share in the firm to an outsider without the consent of all the other partners. The rule follows from the principal-agent relation: since a new owner would be able to bind everyone else, no one can be forced to accept him.
Definite name of the firm — the partners must carry on business under some agreed firm name. The name may not so closely resemble that of an existing firm as to mislead the public, nor suggest government patronage.
Mutual agency — the business may be carried on by all the partners or by any one of them acting for all. This is the general working expression of the principal-agent relationship, and it is often described as the true test of partnership.
Registration is optional — the Act does not compel a firm to register itself. An unregistered firm is perfectly lawful, but it loses certain rights of enforcement, which is why most firms register in practice.
Only individuals can be partners — a firm cannot itself become a partner in another firm, because a firm is not a person in law. Where two firms wish to associate, it is their individual partners who become partners in the new firm.

Business Example

Professional Practice As A Firm Chartered accountants, lawyers and doctors in India commonly practise as partnership firms rather than as companies. Their work depends on personal trust and professional judgement, the number of owners stays small, and clients deal directly with a named partner who is personally answerable for the advice given.

Taken together, these characteristics explain the balance the form strikes. Mutual agency and freedom from formality make a firm quick to set up and easy to run, while unlimited liability and the absence of a separate legal entity keep the owners exposed to everything the business does. The next section weighs the two sides against each other.

6.3 Evaluation Of Partnership: Merits And Demerits

No form of organisation is good or bad in itself; it is suitable or unsuitable for a particular size and kind of business. Partnership is judged against the two forms on either side of it — the sole proprietorship it improves upon, and the joint stock company it stops short of. Almost every merit it carries comes from the freedom of a private agreement, and almost every demerit comes from the same source.

Merits Of Partnership

Ease of formation — a firm needs only an agreement between the partners. There is no compulsory registration, no prescribed document to be filed and very little expense, so a business can be started quickly and closed down just as easily.
Larger financial resources — several partners contribute capital instead of one, and lenders look to the private property of all of them before advancing money. A firm can therefore raise more funds, and raise them on easier terms, than a sole trader.
Combined abilities and specialisation — partners are usually chosen for what they bring to the business, so one may handle purchases, another accounts and a third selling. Work is divided according to capability, and each partner grows more skilled in the area he attends to.
Balanced decisions — important matters are settled after consultation among the partners. Several minds examining the same proposal reduce the risk of a hasty or one-sided judgement, which is the standing weakness of single ownership.
Secrecy of affairs — a firm is not required to publish its accounts. Its costs, margins and customers stay known only to the partners, which matters in trades where a competitor could act on such information.
Flexibility of operations — the capital, the scale, the line of business and even the membership of the firm can be altered by mutual consent alone. No legal permission is needed to change what the firm does, so it can adjust quickly to a change in the market.
Sharing of risk — losses fall on several persons instead of one. Because the burden of a bad year is divided, a firm can attempt ventures that a single owner would find too risky to undertake.
Care in operations — since a partner’s private property is at stake, each of them has a direct reason to watch expenses and to avoid reckless commitments. Unlimited liability, which is a demerit in law, works as a discipline in practice.
Protection of a minor’s interest — a minor cannot be made a partner, but he may be admitted to the benefits of the firm with the consent of all partners. He then shares profits while his liability stays limited to his share.
Close personal relations — the owners are few and are usually present in the business. They deal directly with employees, suppliers and regular customers, and the goodwill built up in this way is difficult for a larger organisation to match.

Demerits Of Partnership

Unlimited liability — the private assets of the partners can be taken to pay the firm’s debts. The liability is joint and several, so a creditor may recover the whole amount from whichever partner is able to pay, leaving that partner to claim contribution from the rest.
Risk of implied authority — every partner can bind the firm by acts done in the ordinary course of business. One careless or dishonest partner can therefore commit the others to a contract they never approved, and they must honour it.
Instability — the firm is disturbed by the death, insolvency, insanity or retirement of a partner, and in a partnership at will any partner may end it by notice. The business has no assured continuity beyond the persons who own it.
Delay in decision-making — important decisions need the agreement of all the partners. When they are not of one mind, an opportunity may be lost while the matter is still being discussed.
Conflicts and frictions — there is no single centre of authority, because each partner has a right to take part in management. Differences over policy, effort or the division of work are common and can paralyse a firm.
Difficulty in transfer of interest — a partner cannot sell his share to an outsider without the consent of all the others. Capital once put into a firm is difficult to withdraw, which discourages investors from joining.
Limited resources — the number of partners is restricted, so the capital and managerial talent a firm can assemble has a ceiling. Beyond a certain size the business must convert itself into a company to grow further.
Lack of public confidence — the firm publishes no accounts and files no returns for public inspection. Outsiders have little reliable information about its financial position, and large contracts often go to organisations that can be examined.
Continuing responsibility after retirement — a retiring partner remains liable for the firm’s acts until a public notice of his retirement or of the dissolution is given. Liability does not end merely because a partner has stopped working in the firm.
Effects of mutual differences — every partner knows the firm’s records and trade secrets. A partner who leaves after a quarrel carries that knowledge with him, and may use it in a competing business.

Do Not Mix Up

Joint Liability And Several Liability Joint liability means the partners can be sued together for the firm’s debt. Several liability means any one of them can be sued alone for the whole of it. Partners in a firm carry both, so a creditor may choose either course.

Case Snippet

Case 6.1 — A Supplier Comes To The House Naveen and Sushma run a furniture firm as equal partners. Naveen orders timber worth a large sum from a regular supplier while Sushma is away, and the firm is later unable to pay for it. The supplier obtains a decree and moves against Sushma’s personal bank deposits, although she neither placed the order nor knew of it. Q. Name the two characteristics of partnership that together explain why Sushma must pay, and state one merit of the same form that Naveen and Sushma enjoyed while the firm was doing well.

Suitability Of The Form

Weighing the two sides, partnership suits a medium-sized business run by a small group of people who trust one another and can work together — retail and wholesale trading houses, small manufacturing units, and professional practices. It is unsuited to a business that needs very large capital, that must last beyond the lives of its owners, or that expects to raise money from the general public. Such a business is better organised as a joint stock company.

Try Yourself

Ask a shopkeeper you know well whether the business has one owner or more, and note one difficulty he mentions about the way ownership is arranged.

6.4 Difference Between Partnership And Sole Proprietorship

Partnership grew out of sole proprietorship, so the two forms share a good deal. In both, the owners run the business themselves, both are cheap to start, and in both the liability of the owners is unlimited. The differences arise from one fact alone: a firm has more than one owner. Ownership by more than one person brings in an agreement, a division of work, a sharing of risk and a need for consent — and each of these changes something about how the business behaves. The comparison is set out in Table 6.1.

Table

Two entries in the table deserve care. Liability is not a point of difference: it is unlimited in both forms, and a student who writes that partners enjoy limited liability has confused a firm with a company. Nor is registration a point of compulsion; the Act merely provides a procedure that a firm may use, and the difference is that a sole proprietorship has no such procedure available to it at all.

Choosing Between The Two

The choice turns on what the business is short of. A proprietor who has enough capital and skill for the scale at which he trades gains nothing by taking a partner, and loses the speed and secrecy of deciding alone. A proprietor who cannot fund the next stock purchase, or who is losing customers because he cannot be in two places at once, gains capital, help and a shared risk — and pays for them in consultation, in a share of the profit and in the risk of being bound by another person’s acts.

Business Example

Taking In A Partner To Expand A single owner running one cloth shop wants to open a second in a nearby town. He cannot fund the stock and cannot supervise both counters himself. Admitting a partner who brings capital and agrees to manage the new shop solves both problems at once, which is the commonest reason a proprietorship becomes a firm.

Try Yourself

Name one business you use regularly that seems to have a single owner, and one that seems to have more than one. State what in each case suggested the answer.

6.5 Types Of Partners

In law every partner stands on the same footing, but in practice partners do not all do the same thing. Some put in capital and run the business, some put in capital and stay away from it, and some put in nothing at all yet find themselves answerable for the firm’s debts. Partners are therefore classified by what they contribute — capital, management, name — and by the liability each of these attracts.

The classification matters for a practical reason. A person dealing with a firm needs to know whom he can hold liable, and a person joining a firm needs to know what he is taking on. Liability does not follow from the label a partner is given; it follows from what he has done or allowed others to believe.

Partners Classified By Their Role

Active or working partner — he contributes capital, takes an active part in the management of the firm and shares its profits and losses. He is a full partner in every sense, his liability is unlimited, and on retiring he must give public notice, failing which he continues to be liable for acts done by the firm afterwards.
Sleeping or dormant partner — he contributes capital and shares profits and losses, but takes no part in the day-to-day working of the business. His liability is nevertheless unlimited, because he is a partner in fact; only his role, not his risk, is limited.
Nominal partner — he neither contributes capital nor shares profits nor manages the firm, and lends only his name to it, usually because that name carries reputation in the trade. He is liable to outsiders who dealt with the firm believing him to be a partner, which makes his the most one-sided position of all.
Partner in profits only — he shares the profits of the firm but has agreed not to bear its losses. The arrangement binds the partners among themselves; towards outsiders his liability remains unlimited, since a private agreement cannot limit what a creditor may claim.
Secret partner — he is a partner in the full sense, contributing capital and often taking part in management, but his association with the firm is not disclosed to the public. His liability is unlimited, and it does not depend on outsiders knowing that he exists.
Partner by estoppel — he is not a partner at all, but by his own words or conduct he has represented himself as one. A person who gave credit to the firm on the strength of that representation may hold him liable as though he were a partner.
Partner by holding out — he is likewise not a partner, but the firm has represented him as one and he, knowing this, has not denied it. His silence is treated as consent, and he becomes liable to anyone who dealt with the firm on that belief.

Do Not Mix Up

Partner By Estoppel And Partner By Holding Out Both attract the same liability, and the difference is only in who made the representation. In estoppel the person represents himself as a partner; in holding out the firm represents him and he fails to deny it.

The three positions that students most often confuse are those of the active, the sleeping and the nominal partner, because each of them combines contribution, management and liability differently. Table 6.2 sets them side by side.

Table

The last row is the one to fix in mind. Whatever a partner contributes, and whether or not the public knows of him, his liability to outsiders is unlimited. What varies between these positions is the share of profit and the right to manage, not the extent of the risk.

Minor Admitted To The Benefits Of Partnership

A minor cannot become a partner, because he is not competent to contract. With the consent of all the partners, however, he may be admitted to the benefits of the firm. He is then entitled to an agreed share of the profits and may inspect and copy the firm’s accounts, but he cannot take part in management, and his liability is limited to his share in the property and profits of the firm.

On attaining majority he must decide where he stands. If he gives public notice within six months that he does not wish to continue, he ceases to have any connection with the firm. If he gives no such notice, or elects to remain, he becomes a full partner from the date on which he was first admitted to the benefits, and his liability from that date becomes unlimited.

Definition

Minor Admitted To The Benefits Of Partnership A minor is not a partner but, with the consent of all the partners, may be admitted to share the profits and property of the firm. He may inspect its accounts, cannot take part in management, and his liability is limited to his share in the firm.

6.6 Types Of Partnership

Partners may choose the terms on which they associate, and two of those terms matter enough to give rise to a classification of firms. The first is how long the partnership is to last, and the second is how far each partner is to be liable. The first affects when and how the firm can be brought to an end; the second affects how much a partner stands to lose. FC 6.2 sets out the classification.

Flowchart

FC 6.2 — Types Of Partnership Partnership → On the basis of duration, On the basis of liability; On the basis of duration → Partnership at will, Particular partnership; On the basis of liability → General partnership, Limited liability partnership

6.6.1 Classification On The Basis Of Duration

Partnership at will — no period is fixed for the duration of the firm and no particular undertaking is named. It continues as long as the partners wish, and any partner may bring it to an end by giving notice in writing to the others of his intention to dissolve it. This freedom is convenient, but it makes the firm’s continuance depend on the will of every single partner.
Particular partnership — the firm is formed for a specific venture or for a fixed period, such as constructing one building or completing one contract. It comes to an end automatically when the venture is completed or the period expires, and no notice is needed to dissolve it.

Where a firm formed for a fixed term carries on business after the term has ended, and the partners continue as before, it is treated as a partnership at will from that point onward.

Definition

Partnership At Will A partnership at will is one in which no fixed period is agreed for the duration of the firm and no particular venture is specified. It may be dissolved at any time by any partner giving notice in writing to all the other partners.

Do Not Mix Up

Partnership At Will And Particular Partnership A partnership at will has no fixed end and must be ended by notice. A particular partnership has its end already built into it, and dissolves by itself when the venture is finished or the agreed period runs out.

6.6.2 Classification On The Basis Of Liability

General partnership — this is the ordinary firm governed by the Indian Partnership Act, 1932. The liability of every partner is unlimited, joint and several; each partner has a right to take part in management, and the acts of one bind the rest. Registration is optional, and the firm is affected by the death, insolvency or retirement of a partner.
Limited liability partnership — this is a separate form created by the Limited Liability Partnership Act, 2008, and is the practical answer in India to the demand for a firm with limited liability. Each partner’s liability is limited to the contribution he has agreed to make, so his private property is not at risk for the firm’s ordinary debts.

A limited liability partnership differs from a general partnership in more than the extent of liability. It must be incorporated with the Registrar of Companies, so registration is compulsory rather than optional. It is a body corporate with a legal existence separate from its partners and with perpetual succession, so the death or retirement of a partner does not disturb it. It must have at least two partners, of whom at least two are designated partners answerable for its statutory compliances. In return for these protections it accepts the filing and disclosure obligations that a general partnership escapes.

Business Example

Why Professional Firms Move To An LLP A growing firm of consultants faces a real difficulty: one partner’s mistake on one assignment can expose every other partner’s personal savings. Converting to a limited liability partnership confines each partner’s liability to his agreed contribution, while keeping the flexible internal arrangements that a partnership allows and a company does not.

The choice between the two turns on what the partners fear more. A small firm that borrows little and knows its customers may accept unlimited liability for the sake of secrecy and freedom from filing. A firm that takes on large contracts, or whose work carries a risk of claims, will usually prefer the protection of limited liability and accept the compliance that comes with it.

6.7 Formation Of Partnership And The Partnership Deed

A partnership can arise only by agreement. The agreement may be express or implied, and if express it may be oral or written; the law insists on none of these forms. Two persons who begin trading together on agreed terms are partners from that moment, whether or not a word of it has been put on paper.

What the law permits and what prudence requires are, however, different things. Memory fails, terms are recalled differently, and the questions that matter most — who gets what share, who may withdraw how much, what happens when a partner dies — are exactly the questions that arise when relations have already soured. Partners therefore reduce their agreement to writing before the business begins, so that a dispute is settled by reference to a document rather than by argument. When the terms are written on stamped paper and signed by all the partners, the document is called the partnership deed.

Definition

Partnership Deed A partnership deed is the written agreement, signed by all the partners and executed on stamped paper, which sets out the terms and conditions of the partnership and the rights, duties and obligations of the partners among themselves.

The steps by which a firm is brought into existence are summarised in FC 6.3.

Flowchart

FC 6.3 — Steps In Forming A Partnership Firm Selecting the partners and the line of business → agreeing the terms among them → drafting the deed → executing it on stamped paper and signing it → applying to the Registrar of Firms for registration (optional)

Contents Of A Partnership Deed

The contents of a deed depend on the nature of the business, and no list is exhaustive. A well-drawn deed will ordinarily provide for the following.

Name and address of the firm — the name under which business is to be carried on, together with the principal and other places of business.
Names and addresses of the partners — so that the persons bound by the deed are identified beyond doubt.
Nature and scope of the business — what the firm will do, and the limits beyond which it will not go without fresh agreement.
Duration of the partnership — whether the firm is at will, or is for a fixed period or a particular venture.
Capital contributed by each partner — the amount each has brought in, and the source from which further capital is to come if needed.
Profit-sharing ratio — the proportion in which profits and losses are to be divided. If the deed is silent, the Act divides them equally, however unequal the capitals may be.
Interest on capital and on drawings — whether interest is to be allowed on capital and charged on drawings, and at what rate. In the absence of agreement no interest is allowed on capital.
Drawings of partners — how much each partner may withdraw for personal use, and at what intervals.
Salary or commission to partners — whether a working partner is to be remunerated for his services. No partner is entitled to a salary unless the deed provides for one.
Loans by partners to the firm — whether the firm may borrow from a partner, and on what terms of interest and repayment. A partner who advances a loan beyond his capital is entitled to interest at the rate laid down in the Act.
Rights, duties and division of work — who is to manage which part of the business, and what authority each partner is to have.
Maintenance and audit of accounts — which partner is to keep the books, what system is to be followed, and whether the accounts are to be audited and by whom.
Admission, retirement and expulsion of partners — the conditions on which a new partner may be taken in, a partner may retire, or a partner may be required to leave.
Death of a partner — whether the firm is to continue with the remaining partners, and how the deceased partner’s share is to be settled with his legal heirs.
Valuation of goodwill — the method by which goodwill is to be valued when a partner is admitted, retires or dies.
Dissolution and arbitration — the manner in which the firm may be dissolved and its accounts settled, and the person who is to act as arbitrator if the partners fall out.

What Happens When The Deed Is Silent

A deed cannot foresee everything, and many firms operate on a short one. Where the deed says nothing on a point, the provisions of the Indian Partnership Act, 1932 apply in its place: profits and losses are shared equally, no partner receives a salary, no interest is allowed on capital, and every partner has a right to take part in management and to inspect the books. Partners who want any other arrangement must say so in the deed, because silence is not neutral — it hands the decision to the Act.

Try Yourself

Draw up in your notebook the five clauses you would insist on if you were forming a firm with a friend, and state in one line why each of them matters.

6.8 Registration Of Partnership

Registration of a firm means getting its particulars entered in the Register of Firms maintained by the Registrar of Firms, an officer appointed for the purpose by every State Government. It is not compulsory under the Indian Partnership Act, 1932, and an unregistered firm is a perfectly lawful business. What the Act does instead is attach disabilities to non-registration, so that a firm which stays out of the register loses the power to enforce its rights in a court. Registration is therefore optional in form and close to necessary in practice.

Two points are worth fixing at the outset. First, what is registered is the firm and not the partnership deed; the deed is a private document between the partners and needs no registration of its own. Second, registration may be applied for at the time the firm is formed or at any later time during its existence, so a firm that begins unregistered can put itself right later.

Procedure Of Registration

An application is made to the Registrar of Firms of the State in which the place of business is situated, in the prescribed form and with the prescribed fee. The steps are summarised in FC 6.4.

Flowchart

FC 6.4 — Procedure For Registration Of A Firm Filing the prescribed application form with the fee → signing and verification by all the partners or their authorised agents → examination of the particulars by the Registrar of Firms → entry of the particulars in the Register of Firms → issue of the certificate of registration

The application must state the following particulars.

The name of the firm.
The principal place of its business.
The other places, if any, where it carries on business.
The names and permanent addresses of all the partners.
The date on which each partner joined the firm.
The duration of the firm, if any duration has been fixed.

The application is signed and verified by all the partners or by their authorised agents. The Registrar, once satisfied that the requirements have been complied with, records an entry in the Register of Firms and issues a certificate of registration. Any later change in these particulars — a new partner admitted, a place of business added, the firm’s name altered — must be notified to the Registrar, since the entry is treated as the authoritative record of the firm.

Advantages Of Registration

Right to sue outsiders — a registered firm can file a suit against a third party to enforce a contract, which is the practical reason most firms register. This right is examined in 6.9.
Right of a partner to sue the firm and the other partners — a partner of a registered firm can go to court to claim his share of profits or a settlement of accounts, instead of depending on the goodwill of his co-partners.
Easier settlement of a deceased partner’s account — the entry in the register establishes who the partners were and from what date, which helps the legal representatives of a deceased partner in claiming his share.
Credit and confidence — banks and large suppliers can verify the constitution of the firm from a public record before lending or supplying on credit. Registration therefore improves the firm’s standing in the market.
Information for an incoming partner — a person considering joining a firm can inspect the register and learn who the existing partners are and when each of them joined, before committing himself to unlimited liability.

Business Example

The Certificate A Supplier Asks For A firm bidding for a supply contract is usually asked for its registration certificate along with its bank details. The buyer is not being difficult: an unregistered firm cannot sue him if he defaults, but neither can he rely on the firm’s own record of who its partners are.

Try Yourself

Note down the six particulars a firm must give the Registrar, and mark the two that an outsider dealing with the firm would find most useful.

6.9 Consequences Of Non-Registration

The Act does not punish a firm for staying out of the register, and it does not declare an unregistered firm illegal. It works in a quieter way: it takes away the firm’s access to the courts while leaving everyone else’s access to the courts intact. The result is a business that can be sued but cannot sue, which in a trade that runs on credit is a serious disability.

Do Not Mix Up

Unregistered And Illegal An unregistered firm is a lawful business. Its contracts are valid, its profits are its own and its partners are bound by their agreement. What it lacks is not legality but the right to enforce its claims in a court of law.

Disabilities Of An Unregistered Firm

The firm cannot sue a third party — it cannot file a suit to enforce a right arising out of a contract. If a customer refuses to pay for goods supplied, the firm has no legal means of recovering the money, and the debt stands to be written off.
A partner cannot sue the firm or his co-partners — he cannot go to court to claim his share of the profits, his salary under the deed or a settlement of accounts. Within the firm, a partner who is being denied his due has no remedy but persuasion.
The firm cannot claim a set-off beyond the prescribed limit — when a third party sues the firm, the firm cannot set off against that claim a debt of its own owed by the same party, except up to the amount the Act allows. It must pay in full and cannot use its own claim as a defence.

Rights That Non-Registration Does Not Affect

The disabilities are aimed at the firm and its partners, and stop there. The following rights survive.

Third parties can sue the firm — an outsider’s right to enforce his claim against the firm and its partners is untouched. The restriction runs one way only, which is precisely what makes it dangerous for the firm.
A partner may sue for dissolution or for accounts of a dissolved firm — a partner is not trapped in the arrangement; he may go to court to have the firm dissolved and its accounts settled.
An official receiver or assignee may realise the property of an insolvent partner — the insolvency machinery operates regardless of whether the firm is registered.
Firms with no place of business in India are unaffected — the requirement applies to firms carrying on business in India, and does not touch a firm situated outside it.
Claims of small value in the courts prescribed for them are unaffected — suits below the limit fixed for such courts may still be brought.

Case Snippet

Case 6.2 — The Bill That Cannot Be Recovered Harmony Traders, an unregistered firm dealing in packaging material, supplies goods on credit to a manufacturer who then refuses to pay, disputing the quality. The partners consult a lawyer and are told that the firm cannot file a suit for recovery. Meanwhile another supplier, whose own bill the firm has not paid, has already sued the firm and obtained a decree against it. Q. State the consequence of non-registration illustrated here, and explain why the second supplier’s suit succeeded while the firm’s own claim could not be brought.

Registering Later

Because a firm may be registered at any time during its existence, non-registration is a curable condition. The cure is not retrospective in the way partners often hope, however: what matters is that the firm stands registered when the suit is filed, so a firm that discovers a disputed bill and applies for registration afterwards will still find the suit it has already filed unsustainable. It is for this reason that most firms register at formation, when the cost is small and no dispute is yet in sight.

6.10 Summary

Partnership is the relation between persons who have agreed to share the profits of a business carried on by all of them or by any of them acting for all. The persons are individually partners and collectively a firm, and the relation arises out of contract and not out of status.
Four conditions must be satisfied before an association is a partnership:

An agreement between two or more persons competent to contract.
A business, carried on with the object of earning profit.
An agreement to share the profits of that business.
The business being carried on by all, or by any of them acting for all — which is the decisive test.

The statutory characteristics of a firm are an agreement between two or more persons, a lawful business, a contractual relationship, a profit motive and a principal-agent relationship. The maximum number of partners at present is fifty.
Its general characteristics are unlimited liability, absence of a separate legal entity, utmost good faith, restriction on transfer of interest, a definite firm name, mutual agency, optional registration and the rule that a firm cannot itself be a partner in another firm.
Mutual agency is the working core of the form: every partner is an agent of the firm and a principal for the others, so an act done by one in the ordinary course of business binds them all.
The merits of partnership are ease of formation, larger financial resources, combined abilities and specialisation, balanced decisions, secrecy, flexibility, sharing of risk, care in operations, protection of a minor’s interest and close personal relations.
Its demerits are unlimited liability, the risk of implied authority, instability, delay in decision-making, conflicts among partners, difficulty in transferring an interest, limited resources, lack of public confidence, continuing responsibility after retirement and the effects of mutual differences.
Partnership suits a medium-sized business run by a small group who trust one another. A business needing very large capital, assured continuity or funds from the public should be organised as a company.
Partnership and sole proprietorship differ in the number of owners, the need for an agreement, capital, management, speed of decision, division of profit, sharing of risk, mutual agency, secrecy, continuity, registration and suitable scale. Liability is unlimited in both, and is therefore not a point of difference.
Partners are classified by what they contribute and by the liability it attracts:

Active, sleeping and secret partners contribute capital and share profits, and all have unlimited liability.
A nominal partner contributes only his name, shares no profits, and is still liable to outsiders.
A partner in profits only shares profits but not losses among the partners, while remaining liable to outsiders.
A partner by estoppel represents himself as a partner; a partner by holding out is represented by the firm and does not deny it. Both are liable to those who relied on the representation.

A minor cannot be a partner but may, with the consent of all partners, be admitted to the benefits of the firm. His liability is limited to his share, and on attaining majority he must give public notice within six months if he does not wish to continue.
Partnerships are classified by duration into partnership at will, dissolvable by notice, and particular partnership, which ends with the venture or the fixed period; and by liability into a general partnership under the Indian Partnership Act, 1932 and a limited liability partnership under the Limited Liability Partnership Act, 2008.
A partnership deed is the written agreement, signed by all partners and executed on stamped paper, setting out the terms of the firm. It commonly provides for the firm’s name and business, capital, profit-sharing ratio, interest, drawings, salary, duties, accounts, admission and retirement of partners, death, goodwill, dissolution and arbitration.
Where the deed is silent the Act applies in its place: profits and losses are shared equally, no salary is payable, no interest is allowed on capital, and every partner may take part in management and inspect the books.
Registration of a firm is optional. It is done by filing the prescribed particulars with the Registrar of Firms, who enters them in the Register of Firms and issues a certificate. What is registered is the firm and not the deed, and registration may be effected at formation or at any later time.
An unregistered firm is lawful but disabled: it cannot sue a third party, its partners cannot sue the firm or one another, and it cannot claim a set-off beyond the prescribed limit. Third parties can nevertheless sue the firm, and a partner may still sue for dissolution or for accounts of a dissolved firm.

6.11 Key Terms

Active or working partner A partner who contributes capital, takes an active part in the management of the firm and shares its profits and losses, with unlimited liability.
Firm The collective name for the persons who have entered into partnership with one another.
Firm name The name under which the partners carry on the business of the firm.
General partnership An ordinary firm under the Indian Partnership Act, 1932, in which the liability of every partner is unlimited, joint and several.
Limited liability partnership A firm incorporated under the Limited Liability Partnership Act, 2008, having a separate legal existence, in which each partner’s liability is limited to his agreed contribution.
Mutual agency The rule that every partner is an agent of the firm and a principal for the other partners, so that an act done by one in the ordinary course of business binds them all.
Nominal partner A person who lends only his name to a firm, contributing no capital and taking no share in profits, but who remains liable to outsiders as a partner.
Partner by estoppel A person who is not a partner but who, by his own words or conduct, has represented himself as one, and is therefore liable to those who dealt with the firm on that belief.
Partner by holding out A person who is not a partner but whom the firm has represented as one and who, knowing this, has not denied it, and is therefore liable to those who relied on the representation.
Particular partnership A partnership formed for a specific venture or for a fixed period, which comes to an end automatically when the venture is completed or the period expires.
Partnership The relation between persons who have agreed to share the profits of a business carried on by all of them or by any of them acting for all.
Partnership at will A partnership for which no period of duration and no particular venture has been fixed, and which any partner may dissolve by giving notice in writing to the others.
Partnership deed The written agreement, signed by all the partners and executed on stamped paper, setting out the terms of the partnership and the rights and duties of the partners.
Register of Firms The record of registered firms maintained by the Registrar of Firms of a State, in which the prescribed particulars of a firm are entered.
Registration of a firm The optional process of getting the prescribed particulars of a firm entered in the Register of Firms and obtaining a certificate of registration.
Sleeping or dormant partner A partner who contributes capital and shares profits and losses but takes no part in the day-to-day working of the firm, and whose liability is nevertheless unlimited.
Unlimited liability The liability of a partner for the debts of the firm to the full extent of his private property, jointly with and severally from the other partners.
Utmost good faith The duty of every partner to act honestly towards the others, render true accounts, disclose what is material to the firm’s business and make no secret profit from it.

6.12 Points To Ponder

Mutual agency makes a firm workable, because one partner can act for all without collecting signatures for every contract. It also means a careful partner can be ruined by a careless one. Is the trade-off a fair price for the convenience, or should partners be free to limit each other’s authority towards outsiders?
The law lets a firm exist without any written deed, and supplies its own terms where the deed is silent. Does this freedom help small businesses that could not afford legal advice, or does it leave the weaker partner unprotected at exactly the moment he needs protection?
Registration is optional in name, yet an unregistered firm cannot enforce its own contracts. Is it honest to call such a requirement optional, and would it be better to make registration compulsory and say so plainly?
A nominal partner contributes no capital, draws no profit and takes no part in management, but can be made to pay the firm’s debts. What justifies holding him liable, and would a person ever have good reason to accept such a position?
A limited liability partnership removes the greatest demerit of the form, but brings with it registration, filing and public disclosure. For a firm of four partners running a steady business, which of the two arrangements would you defend, and on what grounds?
Secrecy is counted a merit of partnership and lack of public confidence a demerit, yet both arise from the same fact — that a firm publishes nothing. Can a business have one without the other?

6.13 Objective Questions

Which of the following is the decisive test of the existence of a partnership? [1]

Contribution of capital by every person concerned
The business being carried on by all, or by any of them acting for all
Execution of a written agreement on stamped paper
Registration of the firm with the Registrar of Firms

Assertion (A): The liability of a sleeping partner for the debts of the firm is unlimited. Reason (R): A sleeping partner contributes capital and shares profits but takes no part in the day-to-day management of the firm. [1]

Both (A) and (R) are true, and (R) is the correct explanation of (A)
Both (A) and (R) are true, but (R) is not the correct explanation of (A)
1. is true, but (R) is false
1. is false, but (R) is true

A partnership formed for one specific venture, which dissolves automatically when that venture is completed, is called a ______ partnership. [1]
State whether the following statement is true or false: A firm that has not been registered with the Registrar of Firms is carrying on business unlawfully. [1]
Match Column A with Column B and choose the correct option. [1]

Nominal partner
Minor admitted to the benefits of a firm
Partnership at will
Register of Firms

May be dissolved by any partner giving notice to the others
Contributes no capital and shares no profits, yet is liable to outsiders
Maintained by an officer appointed by the State Government
Liability confined to his share in the property and profits of the firm

(i)–(B), (ii)–(D), (iii)–(A), (iv)–(C)
(i)–(D), (ii)–(B), (iii)–(C), (iv)–(A)
(i)–(B), (ii)–(A), (iii)–(D), (iv)–(C)
(i)–(C), (ii)–(D), (iii)–(A), (iv)–(B)

6.14 Check Your Concepts

Define a partnership deed and state one reason why partners prefer to have one even though the law does not require it. [2]
Distinguish between a partner by estoppel and a partner by holding out. [3]
Registration of a firm is described as optional, yet an unregistered firm cannot enforce its own contracts in a court. Explain why the requirement is still called optional, and state two disabilities such a firm suffers. [3]
‘Sharing of profits is evidence of partnership but is not conclusive proof of it.’ Explain this statement with an example. [4]
Explain any three merits and any three demerits of the partnership form of organisation, giving in each case the reason from which it arises, and state the kind of business for which the form is suitable. [6]

6.15 Case-Based Questions

Ritika and Farhan carry on a printing business as partners under the name Crescent Press. The firm is not registered. Their friend Ganesh, a well-known figure in the local trade, allows the firm to describe him as a partner in its letterhead, although he has brought in no capital and takes no share of the profits. On the strength of the letterhead, a paper merchant supplies goods on credit. The firm later fails to pay the merchant, and separately finds that a customer who owes it a large sum has refused to settle the bill.

Identify the position that Ganesh occupies in relation to the firm, and state whether the paper merchant can recover his dues from him. [2]
Explain why Crescent Press cannot take the defaulting customer to court, and state one step the partners should have taken at the time of forming the firm. [3]