Partnership Firm

What is a Partnership Firm?

Persons who have entered into partnership with one another to carry on a business are individually called “Partners“; collectively called as a “Partnership Firm”; and the name under which their business is carried on is called the “Firm Name”.

A partnership firm is not a separate legal entity distinct from its members. It is merely a collective name given to the individuals composing it. Hence, unlike a company which has a separate legal entity distinct from its members, a firm cannot possess property or employ servants, neither it can be a debtor or a creditor. It cannot sue or be sued by others.

Elements of a Partnership Firm

All of 5 elements mentioned above must co-exist in order to constitute a partnership. If any of these is not present, there cannot be a partnership. These 5 essential elements of a partnership firm are explained below in detail.

Maximum No. of Partners in a Partnership is 20

Since partnership is the result of a contract, at least two people are necessary to constitute a partnership. The Indian Partnership Act, 1932 does not mention anything about the maximum no. of partners in a partnership firm but as per the Companies Act, a partnership consisting of more than 10 persons for a banking business and more than 20 persons for any other business would be considered as illegal. Hence, these should be regarded as the maximum limits to the number of partners in a partnership firm.

Contract for Partnership

Partnership is the result of a contract. It does not arise from status, operation of law or inheritance. Thus, at the time of death of the father, who was a partner in the partnership firm, the son can claim share in the partnership property but cannot become a partner unless he enters into a contract for the same with other persons concerned. 

Similarly, the members of a HUF carrying on a family business cannot be called partners for their relation arises not from any contract but from status. Thus, a “contract” is the very foundation of partnership.

Carrying on of Business in a Partnership

The third essential element of a partnership is that the parties must have agreed to carry on a business.  The term “business” is used in its widest sense and includes every trade, occupation or profession. Therefore, if the purpose us to carry on some charitable work, it will not be a partnership.

Similarly, if a number of persons agree to share the income of a certain property or to divide the goods purchased in bulk amongst them, there is no partnership and such persons cannot be called partners because in neither case they are carrying on a business.

Sharing of Profits

This essential element provides that the agreement to carry on business must be with the object of sharing profits amongst all the partners. Thus, there would be no partnership where the business is carried on with a philanthropic motive and not for making a profit or where only one of the persons is entitled to the whole of the profits of the business. The partners may however, agree to share the profits in any ratio they like.

Mutual Agency in a Partnership

The fifth element in the definition of partnership provides that the business must be carried on by all the partners or any (one or more) of them acting for them all, i.e. there must be a mutual agency.

Thus, every partner, is both an agent and principal for himself and other partners, i.e. he can bind by his acts the other persons and can be bound by the acts of other partners. The importance of the element of mutual agency lies in the fact that it enables every partner to carry on the business on behalf of others.

Types of Partners

The different classes of partners can be derived based on the extent of liability in a partnership firm.

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Active/ Actual/ Ostensible Partner

When a partner of a partnership firm,

  1. has become a partner by an agreement;
  2. actively participates in the conduct of the partnership.

The partner of the firm acts as a representative of other partners for all the acts carried out in the usual business lifecycle of the business. In the event of a retirement of a partner, the person must give a public notice to absolve himself of their liabilities for acts carried out by the other partners after his retirement.

Sleeping or Dormant Partner

A Sleeping or a Dormant Partner is a partner,

  1. who is a partner by agreement;
  2. who does not actively take part in the conduct of the business.

These partners share their profits and losses and are liable to third parties for the business carried out by the partnership firm. However, they are not required to give public notice of their retirement from the partnership firm.

Nominal Partner

A nominal partner is an individual who lends his name to the partnership form. When this is done without having any real interest in the business, the person is a nominal partner. This kind of a partner is not entitled to share the profits of the firm. This partner has neither invested in the firm nor takes part in how the business is run at the firm. Although, such a partner is liable to third parties for all the actions taken by the firm.

Partner in Profits only

This is a partner who is entitled to have a share of the profits without being liable to the losses. This kind of a partner is liable to third parties only for acts of the gain.

Differences between a

Partnerships vs. Company

Partnership

Legal Status

A firm is not a legal entity. Therefore, it has no legal identity distinct from the personalities of its constituent members.

Agency

In a firm, all the partners are an agent for each other, as well as of the firm.

Distribution of Profits

The profits of a firm must be distributed among the partners according to the terms stated in the partnership deed.

Extent of Liability

In a partnership, the liability of the partners is unlimited. This means that every partner is liable for the debts of a firm incurred during the business of the firm. These debts may be recovered the partner’s private property if the joint estate is insufficient to meet the needs entirely.

Property

The firm’s property is that which is called a “Joint Estate” of all the partners. It does not belong to anybody distinct in law from its members.

Transfer of Shares

A share in a partnership can’t be transferred to another individual or partner without the consent of all the partners

Company

Legal Status

A company is considered a separate legal entity distinct from its members.

Agency

In a company, a member is not an agent of any other member nor the company. A member’s actions do not bind either.

Distribution of Profits

There are no compulsions to distribute its profits among its members. A portion of the profits becomes distributable among the shareholders when dividends are declared.

Extent of Liability

In a company that is limited by shares, the liability of a shareholder is limited to the amount, if any, unpaid on his shares. In the case of a guarantee company, the responsibility is limited to the amount for which the shareholder has agreed to be liable. However, there may be companies where the liability of a member is unlimited.

Property

In a company, its properties are separated from that of its members who can receive it back only in the form of a dividend or a refund of the capital.

Transfer of Shares

A shareholder may transfer his shares, subject to the provisions contained in its Articles. In the case of a public limited company whose shared are quoted on the stock exchange, the transfer of shares is usually restricted.

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