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Modes of dissolution of a firm

The modes of dissolution of a firm are contained in Sec. 40 to 44 of Indian Partnership Act. The dissolution of a firm may either be
  • Dissolution without the intervention of Court (i.e. voluntary dissolution)
  • Dissolution with the intervention of the Court (i.e. by Court order)

Dissolution without the intervention of Court

A firm may be dissolved without going to the Court of law and it may take place in any of the following ways:
  • Dissolution by consent of all the partners: A partnership firm may be dissolved with the consent of all the partners at any point of time during its life. This principle applies to all the cases whether the firm is for a fixed period or at will.
  • Dissolution by contract between the partners: A firm may also be dissolved in accordance with the contract between the partners in the same way as a firm is formed with the contract between the partners. This agreement of dissolution may be a part of the original partnership deed or it may have been arrived at later.
  • Dissolution on the happening of certain contingencies: A firm would be automatically dissolved on the happening of any of the following certain contingencies. This is, however, subject to a contract to contrary and the partners may decide that the firm shall not be dissolved in such cases.
  • Expiry of the fixed term: When a firm is constituted for a fixed term, the firm is dissolved on the expiry of such term. If the firm continues it will be partnership at will.
  • On completion of particular venture: Sometimes, a firm is constituted for a particular venture or undertaking. In such case, the firm is dissolved on the completion of such venture. This is however subject to contract to contrary. If the firm continues, it will be partnership at will.
  • Death of a partner: Sometimes, one of the partners of the firm may die during the continuance of the firm. In such a case, the firm is dissolved on the death of the partner. This is also subject to contract to a contrary. The partners may agree to continue the firm with the remaining partners.

Note: When there are only two partners, the death of one partner automatically dissolves the firm since there must be at least two partners to carry on the business.

 

Compulsory dissolution
In the following cases, partnership will be compulsorily dissolved:
  • Insolvency of all partners or all but one partner: When all partners or all but one, have been declared as insolvent, the firm shall be compulsorily dissolved even if the partnership agreement provides that the firm shall not be dissolved on insolvency of any partner. The firm can no longer exist, for there must be at least two partners to continue the firm.
  • Business of the firm becomes unlawful: When the happening of any event makes it unlawful for the business of the firm to be carried on or for the partners to carry it on as a partnership, the firm has to dissolve.
Example

X, a resident in India and Y, a resident in Pakistan, are partners. War breaks out between India and Pakistan. The partnership becomes unlawful and it is dissolved automatically on the outbreak of the war.

 

Note: When a firm is carrying on several separate ventures, the illegality of one or more ventures does not dissolve the firm. The firm continues as long as it is carrying on one lawful business.

  • Dissolution by notice
    • When the partnership is at will, its dissolution can be brought about by any partner by giving a notice to that effect
    • The notice should clearly state the partners intention to dissolve the firm
    • The dissolution by notice takes effect from the date mentioned in the notice or if no date is mentioned, from the date of communication of notice
    • If the firm is not at will, then it cannot be dissolved by a notice of dissolution
Example

Ajay and Vijay were partners in a firm. The partnership deed had provided that the firm can be terminated (dissolved) by mutual agreement only. After some time, Ajay gave a notice of dissolution to Vijay. It was held that the firm cannot be dissolved by the notice of dissolution. The reason for the same is that in this case, firm is not ‘at will’ as the mode of dissolution is provided in the partnership deed itself.

Dissolution with the intervention of the court

Sometimes, a partner or few partners believe that the firm needs to be dissolved, but the other partners do not think in the same way. In such a situation, he can go to the Court and file a suit for dissolution of the firm. The Court will take up the matter only on an application by a partner and on hearing the matter; the Court may or may not allow the dissolution of the firm.
 
The Court may order the dissolution of the firm on any of the following grounds on the application by the partners:
  • Insanity of a partner
    • When a partner has become of unsound mind, a firm may be dissolved by an agreement among the partners or under a clause to this effect in the partnership deed
    • If there is no agreement in this regard, then the partners may approach the Court
    • The suit for dissolution of a firm may be filed by any partner other than the partner who has become insane
    • The suit may also be filed by the legal representative of the insane partner
    • In this case, the firm is not automatically dissolved; it is dissolved by an order of the Court
  • Permanent incapacity
    • When a partner becomes permanently incapable of performing his right or duties, the Court allows the partnership to be dissolved
    • The suit for dissolution of a firm may be filed by any partner other than the partner who has become incapable
    • In this case, the firm is not automatically dissolved; it is dissolved by an order of the Court

Note: It is interesting to know that the above rule is not applicable to the incapacity of a sleeping partner. The reason for the same is that a sleeping partner does not take active part in the business of the firm, and thus, his incapacity is not likely to affect the business of the firm.

  • Misconduct
    • Where the partner is guilty of misconduct, the court may allow the dissolution of the firm
    • It is not necessary that the misconduct should relate to business operation of the firm
    • It is sufficient if the misconduct is capable of damaging the reputation or future prospect of the firm
    • The suit for dissolution of a firm may be filed by any partner other than the partner who is guilty of misconduct
Example

Gambling by a partner is misconduct, although it may, in no way, be connected with the business of the firm, but it still damages the reputation of the firm.

  • Persistent breach of agreement: A partner willfully or frequently commits a breach of agreement relating to the management of affairs of the firm and the other partners find it difficult to carry on the business with him. In this case, the court may allow the dissolution of the firm.
Example

Keeping erroneous accounts and not entering receipts, continuing quarrel between the partners, refusal to meet on matters of business, taking away books of the firm and misappropriations of income etc. are held to be sufficient ground for dissolution of a firm.

  • Transfer of interest: When the partner transfers the whole or part of his share to a third party without the consent of other partners, the court may allow the dissolution of the firm at the instance of any other partner.
  • Continuous losses: Where the prospect of the business have gone down so substantially, for whatever reasons, and it is clear that the business of a firm cannot be carried on, except at losses, the court may be approached by any of the partners seeking dissolution of the firm, and the court may allow dissolution of the firm.
  • Just and equitable grounds: In addition to the above, the court may order dissolution of a firm on just and equitable grounds. A ‘just and equitable ground’ is a ground which is fair and reasonable according to the opinion of the court. This is a general clause to cover unexpected happenings. Sufficient reasons may include dead lock in management, partners not on speaking terms etc.

Note: The right of a partner to file a suit for dissolution on any of the grounds cannot be excluded by an agreement to the contrary.





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