Formation of Partnerships
A partnership is a business arrangement in which two or more people own an entity, and personally share in its profits, losses, and risks. The exact form of partnership used can give some protection to the partners. A partnership can be formed by a verbal agreement, with no documentation of the arrangement at all. However, there may be subsequent disagreements among the owners at a later date, so it makes sense to create a written document that states how certain situations are to be handled. This partnership agreement should at least cover the following topics:
- The rights and responsibilities of each partner
- Whether partners are designated as general partners or limited partners
- The proportions of partnership gains and losses to be apportioned to each partner
- Procedures related to the withdrawal of funds from the partnership, as well as any limitations on these withdrawals
- How key decisions are to be resolved
- Provisions regarding how to add and terminate partners
- What happens to partnership interests if a partner dies
- What steps to follow to dissolve the partnership
- The proportions of residual cash paid out to the partners in a liquidation
In addition to the partnership agreement, the partners must engage in a number of other formation activities that are common to all types of businesses. These actions include:
- Register the business name
- Obtain an employer identification number
- Obtain any licenses required by governments where the partnership plans to operate
- Open a bank account in the name of the partnership
- File an annual informational return with the Internal Revenue Service
Kinds of Partners
1. Active or managing partner:
A person who takes active interest in the conduct and management of the business of the firm is known as active or managing partner.
He carries on business on behalf of the other partners. If he wants to retire, he has to give a public notice of his retirement; otherwise he will continue to be liable for the acts of the firm.
2. Sleeping or dormant partner:
A sleeping partner is a partner who ‘sleeps’, that is, he does not take active part in the management of the business. Such a partner only contributes to the share capital of the firm, is bound by the activities of other partners, and shares the profits and losses of the business. A sleeping partner, unlike an active partner, is not required to give a public notice of his retirement. As such, he will not be liable to third parties for the acts done after his retirement.
3. Nominal or ostensible partner:
A nominal partner is one who does not have any real interest in the business but lends his name to the firm, without any capital contributions, and doesn’t share the profits of the business. He also does not usually have a voice in the management of the business of the firm, but he is liable to outsiders as an actual partner.
Sleeping vs. Nominal Partners:
It may be clarified that a nominal partner is not the same as a sleeping partner. A sleeping partner contributes capital shares profits and losses, but is not known to the outsiders.
A nominal partner, on the contrary, is admitted with the purpose of taking advantage of his name or reputation. As such, he is known to the outsiders, although he does not share the profits of the firm nor does he take part in its management. Nonetheless, both are liable to third parties for the acts of the firm.
4. Partner by estoppel or holding out:
If a person, by his words or conduct, holds out to another that he is a partner, he will be stopped from denying that he is not a partner. The person who thus becomes liable to third parties to pay the debts of the firm is known as a holding out partner.
There are two essential conditions for the principle of holding out : (a) the person to be held out must have made the representation, by words written or spoken or by conduct, that he was a partner ; and (6) the other party must prove that he had knowledge of the representation and acted on it, for instance, gave the credit.
5. Partner in profits only:
When a partner agrees with the others that he would only share the profits of the firm and would not be liable for its losses, he is in own as partner in profits only.
6. Minor as a partner:
A partnership is created by an agreement. And if a partner is incapable of entering into a contract, he cannot become a partner. Thus, at the time of creation of a firm a minor (i.e., a person who has not attained the age of 18 years) cannot be one of the parties to the contract. But under section 30 of the Indian Partnership Act, 1932, a minor ‘can be admitted to the benefits of partnership’, with the consent of all partners. A minor partner is entitled to his share of profits and to have access to the accounts of the firm for purposes of inspection and copy.
He, however, cannot file a suit against the partners of the firm for his share of profit and property as long as he remains with the firm. His liability in the firm will be limited to the extent of his share in the firm, and his private property cannot be attached by creditors.
On his attaining majority, he has to decide within six months whether he will become regular partner of withdraw from partnership. The choice in either case is to be intimated through a public notice, failing which he will be treated to have decided to continue as partner, and he becomes personally liable like other partners for all the debts and obligations of the firm from the date of his admission to its benefits (and not from the date of his attaining the age of majority). He also becomes entitled to file a suit against other partners for his share of profit and property.
7. Other partners:
In partnership firms, several other types of partners are also found, namely, secret partner who does not want to disclose his relationship with the firm to the general public. Outgoing partner, who retires voluntarily without causing dissolution of the firm, limited partner who is liable only up to the value of his capital contributions in the firm, and the like.However, the moment public comes to know of it he becomes liable to them for meeting debts of the firm. Usually, an outgoing partner is liable for all debts and obligations as are incurred before his retirement. A limited partner is found in limited partnership only and not in general partnership.
Authorities, Rights and Liabilities of Partners
The relationship of partners among themselves, their rights and obligations are generally given in the partnership deed. If partnership deed is silent about it, then the partners shall have rights and obligations mentioned in the Partnership Act.
Right of a Partner:
(i) Every partner has a right to take part in the conduct and management of the business.
(ii) Every partner has a right to be consulted before taking important decisions. The decisions should be taken by mutual consent. If the decisions are unimportant, then they can be enforced by majority, but consensus of all partners is necessary for taking important decisions.
(iii) The partners have a right to inspect books of accounts.
(iv) Every partner will have an equal share in profits, unless otherwise mentioned, in partnership deed.
(v) No new partner can be admitted into partnership without the consent of all partners.
(vi) Every partner has a right to receive interest at the rate of 6% per annum on the excess money supplied over his capital.
(vii) Every partner has a right to be indemnified by the firm in respect of expenses incurred or losses suffered for the normal conduct of the business.
(viii) A partner has a right to get the firm dissolved under appropriate circumstances.
(ix) The property of the firm shall be held and used exclusively for the purpose of the business.
Obligations of a Partner:
(i) Every partner should carry on the business to the greatest common advantage. He must perform his duties honestly and diligently.
(ii) A partner is not entitled to get remuneration for the conduct of business, unless otherwise it is specially mentioned in the partnership deed.
(iii) A partner must indemnify the firm for loss suffered because of his fraudulent conduct or willful neglect.
(iv) A partner is bound to keep and render true and correct accounts of the business.
(v) A partner cannot carry on a competing business. If he carries on such business he shall account for and pay to the firm all profits made by him in that business.
(vi) A partner is bound to act within the scope of his authority.
(vii) No partner can make a secret profit of the partnership business by way of commission, etc. If he does so, he must return the money to the firm.
Rights of Partners:
(a) Every partner has a right to take part in the conduct and management of business.
(b) Every partner has a right to be consulted and heard in all matters affecting the business of the partnership.
(c) Every partner has a right of free access to all records, books and accounts of the business, and also to examine and copy them.
(d) Every partner is entitled to share the profits equally.
(e) A partner who has contributed more than the agreed share of capital is entitled to interest at the rate of 6 per cent per annum. But no interest can be claimed on capital.
(f) A partner is entitled to be indemnified by the firm for all acts done by him in the course of the partnership business, for all payments made by him in respect of partnership debts or liabilities and for expenses and disbursements made in an emergency for protecting the firm from loss provided he acted as a person of ordinary prudence would have acted in similar circumstances for his own personal business.
(g) Every partner is, as a rule, joint owner of the partnership property. He is entitled to have the partnership property used exclusively for the purposes of the partnership.
(h) A partner has power to act in an emergency for protecting the firm from loss, but he must act reasonably.
(i) Every partner is entitled to prevent the introduction of a new partner into the firm without his consent.
(J) Every partner has a right to retire according to the Deed or with the consent of the other partners. If the partnership is at will, he can retire by giving notice to other partners.
(k) Every partner has a right to continue in the partnership.
(l) A retiring partner or the heirs of a deceased partner are entitled to have a share in the profits earned with the aid of the proportion of assets belonging to such outgoing partner or interest at six per cent per annum at the option of the outgoing partner (or his representative) until the accounts are finally settled.
Duties of Partners:
(a) Every partner is bound to diligently carry on the business of the firm to the greatest common advantage. Unless the agreement provides, there is no salary.
(b) Every partner must be just and faithful to the other partners.
(c) A partner is bound to keep and render true, proper, and correct accounts of the partnership and must permit other partners to inspect and copy such accounts.
(d) Every partner is bound to indemnify the firm for any loss caused by his willful neglect or fraud in the conduct of the business.
(e) A partner must not carry on competing business, nor use the property of the firm for his private purposes. In both cases, he must hand over to the firm any profit or gain made by him but he must himself suffer any loss that might have occurred.
(f) Every partner is bound to share the losses equally with the others.
(g) A partner is bound to act within the scope of his authority.
(h) No partner can assign or transfer his partnership interest to any other person so as to make him a partner in the business.