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LAB/U2 Topic 5 Law of partnership: Definition, essentials of partnership

Partnership is a form of business organization, where two or more persons join together for jointly carrying on some business. It is an improvement over the ‘Sole –trade business ’, where one single individual with his own resources, skill and effort carries on his own business. Due to the limitation of resources of only a single person being involved in the sole-trade business, a larger business requiring more investments and resources than available to a sole-trader, cannot be thought of in such a form of business organization. In partnership, on the other hand, a number of persons could pool their resources and efforts and could start a much larger business, than could be afforded by any of these partners individually. In case of loss the burden gets divided amongst various partners in a Partnership.

Criteria of Partnership:

Any two or more than two persons can join together for creating Partnership. Section 11 of the Companies Act, 1956 imposes limit as to maximum number of persons in a partnership for the purpose of carrying:

  • Banking Business – There can be maximum of 10 persons.
  • Any other purpose – There can be maximum of 20 persons.

If the number of members in any association exceeds the above stated limit, that must be registered as a company under Companies Act ,1956 otherwise that will be considered to be an illegal association.

As against partnership, where the maximum number of partners can be 10 or 20, depending on the nature of partnership business, there could be possibly much larger number of members in a company.

  • In Private Company – Here there can be maximum of 50 members.
  • In Public Company – Here there is no such limit to the maximum number.

Advantage of Partnership over A Company:

  1. For the creation of partnership just an agreement between various persons is all what you require. In case of a company a lot of procedural formalities which have to be gone through before a company is created.
  2. The partners are their own masters for regulating their affair. A company is subject to a lot of statutory control.
  3. For dissolution of partnership, a mere agreement between the partners is enough But that is not the case of a company which can be wound up by only after certain set of procedure is followed.
  4. Since all the profits are to be pocketed by the partners in a partnership firm, there is a great incentive for the partners to make business successful But that is not in case of a company.
  5. In a Partnership the persons who have entered into are individually called partners and collectively a firm. A partnership firm does not have a separate legal personality. A company is a legal entity different from its members.
  6. A partnership firm means all the partners put together, if all the partners cease to be partners, e.g., all of them die or become insolvent, the partnership firm gets dissolved. A company being a person different from the members, the members may come and go but the company’s life is not affected thereby.
  7. The shareholder of a company can transfer his share to anybody he likes but a partner cannot substitute another person in his place unless all the other partners agree to the same. Similarly, on the death of a member of a company his legal representatives will step into his shoes for the purpose of the rights in the company, but on the death of a partner his legal representatives do not get substituted in his place of partnership.
  8. The minimum number of members in partnership in two and maximum in case of partnership carrying on banking business is 10 and in case of any other business is 20.In the case of a private company the minimum number is 2 and the maximum is 50 whereas in the case of a public company the minimum number should be 7 but there is no limit to the maximum number and therefore, any number of persons can hold shares in a public company.
  9. The liability of the members of a company is limited but the liability of the partners is unlimited.

Essential elements of partnership in business are given below:

This definition contains five elements which constitute a partnership, namely:

(1) There must be a contract;

(2) Between two or more persons;

(3) Who agree to carry on a business?

(4) With the object of sharing profits; and

(5) The business must be carried on by all or any of them acting for all (i.e., there must be mutual agency).

All the above elements must coexist in order to constitute a partnership. If any of these is not present, there cannot be a partnership. We now discus these elements one by one:

  1. Contract:

Partnership is the result of a contract. It does not arise from status, operation of law or inheritance. Thus at the death of father, who was a partner in a 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 Joint Hindu Family carrying on a family business cannot be called partners for their relation arises not from any contract but from status. To emphasise the element of contract, Sec. 5 expressly provides mat “the relation of partnership arises from contract and not from status.”

Thus a ‘contract’ is the very foundation of partnership. It may, however, be either express or implied. Again, it may be oral or in writing (Laxmibai vs. Roshan Lai).

  1. Association of two or more persons:

Since partnership is the result of a contract, at least two persons are necessary to constitute a partnership. The Partnership Act does not mention any thing about the maximum number of persons who can be partners in a partnership firm but Sec. 11 of the Companies Act, 1956, lays down that a partnership consisting of more than 10 persons for banking business and 20 persons for any other business would be illegal. Hence these should be regarded as the maximum limits to the number of partners in a partnership firm.

Only persons competent to contract can enter into a contract of partnership. Persons may be natural or artificial. A company may, being an artificial legal person, enter into a contract of partnership, if authorised by its Memorandum of Association to do so.

Even there could be a partnership between a numbers of companies (Steel Bros. & Co Ltd. Vs. Commissioner of Income-tax). A partnership firm, since it is not recognised as a legal person having a separate entity from that of partners cannot enter into contract of partnership with another firm or individuals (Duli Chand vs. Commissioner of Income-tax).

When a firm (under a firm name) enters into a contract of partnership with another firm or individual, in that case, in the eye of law the members of the firms or firm become partners in their individual capacity (Commissioner of Income-tax vs Jadavji Narsidas & Co.).

  1. Carrying on of business:

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 [Sec. 2(b)].

If the purpose is 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.

Thus, where A and B jointly purchased a tea shop and incurred additional expenses for purchasing pottery and utensils for the job, contributing necessary money half and half and then leased out the shop on rent which was shared equally by them, it was held that they are only co-owners and not partners as they never carried on any business (Govind Nair vs Maga).

Further, in order to be a partnership, the business must be ‘carried on’ which suggests continuity or repetition of acts. Merely a single isolated transaction of purchase and sale by a number of persons does not mean carrying on of the business.

But if a number of articles are purchased at one time and the sales are to go on, profits are to be realised and are to be divided amongst a number of persons, there is a carrying on of business.

Section 8, however, provides that there can be ‘particular partnership’ between partners whereby they engage in a particular adventure or undertaking, which if successful, would result in profit.

Thus, there can be a partnership business as to the working out of a coal mine, or the sowing, cropping, harvesting and sale of a particular crop, or the production of a film because although in each of these cases there is a single adventure but the same requires a series of transactions and continuing relationship (Ram Dass vs Mukut Dharfi).

  1. 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. Impliedly the partnership must aim to make profits because then only profits may be divided amongst 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 partners is entitled to the whole of the profits of the business. The partners may, however, agree to share profits in any ratio they like.

Sharing of losses not necessary:

To constitute a partnership it is not essential that the partners should agree to share the losses (Raghunandan vs. Harmasjee1). It is open to one or more partners to agree to bear all the losses of the business.

The Act, therefore, does not seek to make agreement to share losses a test of the existence of partnership. Section 13(6), however, provides that the partners are entitled to share equally in the profits earned, and shall contribute equally to the losses sustained by the firm, unless otherwise agreed.

Thus sharing of losses may be regarded as consequential upon the sharing of profits and where nothing is said as to the sharing of losses, an agreement to share profits implies an agreement to share losses as well.

It must be noted that even though a partner may not share in the losses of the business, yet his liability vis-a-vis outsiders shall be unlimited because there cannot be ‘limited partnerships’ in our country under the Partnership Act.

Sharing of profits not conclusive test:

Although sharing of profits is an evidence of partnership but this is not the conclusive test of partnership. There may be persons sharing the profits of a business but who do not by that reason become partners.

In this respect Explanation II to Section 6 clearly states: “The receipt by a person of a share of the profits of a business, or of a payment contingent upon the earning of profits or varying with the profits earned by a business, does not of itself make him a partner with the persons carrying on the business; and, in particular, the receipt of such share or payment:

(a) By a lender of money to persons engaged or about to engage in any business,

(b) By a servant or agent as remuneration,

(c) By a widow or child of a deceased partner as annuity, or

(d) By a previous owner or part-owner of the business as consideration for the sale of the goodwill or share thereof, does not itself make the receiver a partner, with the persons carrying on the business.”

The question whether a person sharing profits of a business is a partner or not depends upon the real relation between the parties, as shown by all relevant facts taken together (Sec. 6).

  1. Mutual agency:

The fifth element in the definition of a partnership provides that the business must be carried on by all the partners or any (one or more) of them acting for all, that is, there must be 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 partners and can be bound by the acts of other partners in the ordinary course of business.

To test whether a person is a partner or not, it should be seen, among other things, whether or not the element of agency exists, i’. e., whether the business is conducted on his behalf.

It is on the basis of this test that a widow of a deceased partner or a manager having a share in the profits is not a partner, because business is not carried on her or his behalf. If she or he does something the firm is not legally bound by that.

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. Partners may agree among themselves that some one of them shall not enter into any contracts on behalf of the firm, but by virtue of the principle of mutual agency, such partner can bind the firm vis-a-vis third parties without notice in contracts made according to the ordinary usage of trade.

Of course he can be made liable by other partner’s inter-se for exceeding his authority. In fact, the law of partnership governing relations of the partner’s inter-se and with the outside world is an extension of the law of agency.

In Cox vs. Hickman it was rightly observed: “The law as to partnership is undoubtedly a branch of the law of the principal and agent…. The liability of one partner for the acts of his co-partner is in truth the liability of a principal for the acts of his agent.

Where two or more persons are engaged as partners in an ordinary trade, each of them has an implied authority from the others to bind all by contracts entered into according to usual course of business in that trade.

Every partner in trade is, for the ordinary purposes of the trade, the agent of his co-partners; all are therefore liable for the ordinary trade contract of the other. The public have a right to assume that every partner has authority from his co-partners to bind the whole firm in contracts made according to the ordinary usage of trade.”

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