Tag: rights and liabilities of incoming and outgoing partners

INCOMING AND OUTGOING PARTNERS

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Mansi Tyagi, is a student of Symbiosis Law School, Pune. In this article, she has discussed the rules and principles concerning the Incoming and Outgoing partners in a firm. Also, she has tried explaining in the conclusion, the status of partnership firms after such changes in the constitution of partners.

Who is a Partner?

Section 4 of the Indian Partnership Act, 1932 defines “Partnership”[1] as ‘the relation between persons who have agreed to share the profits of a business carried on by all or any of them acting for all’. And on the same lines, it defines a Partner, the person who enters into such a partnership with another person. In other words, partners are persons working collectively for a common business to share profits. In the case of ‘Mohd. Laiquiddin and Ors. vs. Kamala Devi Misra (Dead) by L.Rs. and Ors.’[2] the hon’ble supreme court went ahead to interpret Section 4 to declare a partnership one purely contractual matter. Now it is important to note what a Partnership Deed is. It is this instrument which formalises the agreed terms of a partnership by the partners. It may be written or oral, but in any case creates a legal agreement. There are a total of nine kinds of partners in any firm. These include:

  1. Active Partners
  2. Quasi Partners
  3. Dormant Partners
  4. Nominal Partners
  5. Sleeping Partners
  6. Salaried Partners
  7. Minor as a Partner
  8. Major Partners
  9. Senior Partners

However, on the basis of the deed effect, there are two more kinds of Partners i.e. Incoming and Outgoing Partners. The new partners are the Incoming Partners while Outgoing Partners can be the retiring partners, the insolvents or the deceased. Chapter V of the Indian Partnership Act, 1932 explicitly lays down the rights and liabilities of these Outgoing and Incoming Partners.

Incoming Partners

Incoming Partners are the new partners who get admitted to the firm. Such admission is subject to any procedure that the firm at its will and understanding adopts to include new members. Section 31[3] of the Partnership Act lays down two rules for the inclusion of new members. Firstly, the new members can only be admitted with the consent of all the existing partners. Secondly, once a person is made a partner in the firm, he shall become jointly liable to only the acts that happened after him joining the firm. Therefore we can say that the legal liabilities of any new member begins only after he is admitted to the firm and not before that.

Outgoing Partners

The Indian Partnership Act states four kinds of situations in which a person may on his own or due to other reasons be ousted from the firm. Sections 32-35 states such four conditions, viz.

  • Retirement of a Partner (Section 32)
  • Expulsion of a Partner (Section 33)
  • Insolvency of a Partner (Section 34)
  • Liability of estate of deceased Partner (Section 35)

Thus, now we will see how the act details these four outgoing conditions of a partner:

1. Retirement of a Partner

There are three ways a partner may retire out of a firm. Firstly, he may retire with the consent of all other existing partners; secondly, if an expressed contract between the partners instructs such retirement, and; thirdly, in situations of partnerships at will, the retiring partner may serve a written notice disclosing his intention to retire. Further, the retiring partner in no circumstances can get off the liabilities of the acts that the firm did when he was an existing member and continues to be liable until a public notice of the retirement is served. Such notice can be either served by the retiring partner or the other existing partners of the firm. However, once a partner retires he may discharge himself from any liability towards any third party through an agreement stating the same between him, the third party and the remaining partners. In absence of any express agreement, there can be an implied notion of the same if the third party is aware of the retirement and went ahead with dealings with the reconstituted firm.

2. Expulsion of a Partner

Generally, a partner can only be expelled from a firm in the presence of a pre-decided procedure through an express contract. For such expulsion to happen, there must be a majority of the partners to agree to the same. Also, such expulsion must be done only in the exercise of good faith. Good Faith is tested through three sets of rules: firstly the expulsion shall be in the interest of the firm; secondly, due notice shall be served to the partner before expelling him and thirdly, the concerned partner shall be given an opportunity to justify the actions that were leading him to an expulsion.  Until all these requirements are fulfilled, a partner cannot be expelled whatsoever. Further, after the expulsion, a partner shall be treated like a retired partner and have the concerned liabilities as under section 32 of the act.

3. Insolvency

Whenever any partner is ‘adjudicated’ as an insolvent, he becomes an outgoing partner and ceases to be a part of the firm from the date of such order of adjudication. Where such insolvency does not ipso facto dissolve the firm, the liabilities of the insolvent partner to the firm changes. The date on which such adjudication of insolvency is given, the partner’s estate is no longer liable to any act done by the firm after such date. Also, in the same way, the firm is no longer liable to the acts done by the insolvent partner.

4. Liability of estate of deceased Partner

Usually, death of a partner renders the partnership firm dissolved. However, the exception to it is an expressed contract stating otherwise. In the case of ‘Mohd. Laiquiddin and Ors. vs. Kamala Devi Misra (Dead) by L.Rs. and Ors.’ the court laid down that the death of a partner automatically dissolves the firm of two members. Also, after the death of a partner, his estate is liable to the firm only to the extent of acts done in the firm during his life. Acts done by the firm after the death of the partner have no liability to be born by the deceased’s estate.

Further, Sections 36 and 37 lays down the rights of the outgoing partners:

1. Rights of outgoing partner to carry on competing business (Section 36)

On leaving the firm, the outgoing partner has the right to start and advertise any business that competes with the firm he left. However, at the same time, if there is no express contract to the contrary, there are restrictions on the outgoing partner to either use the firm’s name he left; or misrepresenting himself as the partner of the same firm. Also, the outgoing partner cannot solicit the customs of the clients of the previous firm while he was still a partner there. The second clause of section 36 talks about the restraint of trade. Herein, any express contract can restrict the outgoing partner from exercising any business similar to that of the firm within a reasonable local limit or time. However, such a contract between the outgoing partner and the existing partners shall be tested on the basis of reasonability. In one such case of ‘Firm Daulat Ram vs. Firm Dharm Chand’[4], when two ice factories under a partnership decided to work one at a time and distribute the accruing profits amongst each other, the restriction was considered reasonable. Section 36(2) of the act is an exception to section 27 of the Indian Contracts Act, 1872 which renders any contract that restricts trade void.

 2. Right of outgoing partner in certain cases to share subsequent profits (Section 37)

When a person dies or becomes an outgoing partner due to any other reason, and the firm still continues to exist and work, such person or his estate through his legal representatives are entitled to the shares in profits made after the person ceased to become a member. The share of profit shall be either attributable to the use of his property share in the firm or interest of six percent per annum on his share of the property in the firm. However, this is only the case where there is no final settlement of accounts between both parties. In the case of ‘Addanki Narayanappa and Ors. vs. Bhaskara Krishtappa and Ors.’[5] the hon’ble supreme court reaffirmed the sharing of profits to the representatives or estate of a deceased partner under section 37. However, this profit sharing is subject to any contract to the contrary. Therefore, in cases where the firm purchases the remaining interests of the outgoing partner in the firm, such partner does not remain further entitled to any profit sharing.

Conclusion – Status of the new firm

One more question that is important is whether a partnership firm dissolves after a new member is added or an existing member ceases to be a part of the firm? This was answered in the case of ‘Tyresoles (India) Calcutta v. Commissioner of Income-Tax, Coimbatore’[6] where the court laid down the status of any firm after inclusion of any new member as reconstitution of the existing firm rather than the complete dissolution of the older firm. However, at the same time the ‘Mohd. Laiquiddin Case’ laid down the principle of a ‘firm dying with the partner’ in case it is a firm of two partners only. But generally, Reconstitution of a firm keeps it subsisting in another form, and thus the inclusion of a new member or exclusion of an existing member are examples of rearranging the original form of the firm into a novel one. It is for this reason that section 38 of the Act lays down that in case of reconstitution of any firm, the guarantees given to the firm or a third party are automatically revoked in absence of any contract to the contrary. It is thus important to note that once the constitution of partners changes in a firm, the liabilities and status of the firm also takes another side.

[1] INDIAN PARTNERSHIP ACT, 1932  Section  4 – Definition of partnership, partner, firm and firm name.

[2] Mohd. Laiquiddin and Ors. vs. Kamala Devi Misra (Dead) by L.Rs. and Ors., (2010) 2 SCC 407.

[3] INDIAN PARTNERSHIP ACT, 1932  Section  31 – Introduction of a partner.

[4] Firm Daulat Ram vs. Firm Dharm Chand, AIR 1934 Lah 110.

[5] Addanki Narayanappa and Ors. vs. Bhaskara Krishtappa and Ors., AIR 1966 SC 1300.

[6] Tyresoles (India) Calcutta v. Commissioner of Income-Tax, Coimbatore, [1963]49ITR515(Mad).

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