The partnership is an agreement between two or more persons for sharing the profits of a business carried on by all or any one of them acting for all. Any change in the existing agreement is known as reconstitution of the partnership firm. Thus, the existing agreement ends and a new agreement is formed with the changed relationship among the members of the partnership firm and its composition.
Reconstitution of a partnership firm takes place whenever there is a change in the profit sharing ratio among the partners, admission of a new partner, retirement of a partner and death or insolvency of a partner.
Forms of Reconstitution of a Partnership Firm
- Change in the profit sharing ratio among the Existing Partners
Sometimes the partners may decide to change their profit sharing ratio due to factors like change in their roles in the firm, change in their capital contribution ratio, etc. Any change in the old profit sharing ratio will amount to a reconstitution of the partnership firm.
For example, X, Y, and Z were partners in a firm sharing equal profits. Due to some reasons, Z shifts to another city and is therefore unable to take part in the business actively. Thus, it is decided that now the new profit sharing ratio shall be 2:2:1. This amounts to the reconstitution of a firm.
2. The Retirement of an Existing Partner
A partner may decide to retire or withdraw from the firm due to reasons such as his age, his bad health, change in firm’s nature of a business, etc. In case of Partnership at Will, a partner may retire at any time. Retirement amounts to a reconstitution of a firm where the number of partners, their capital contribution ratio and also the profit sharing ratio changes. The retiring partner is paid his share of capital, goodwill and revaluation profit or loss.
For example, A, B, and C are partners in the firm sharing profits in the ratio of 3:2:1. A chooses to retire and B and C decide to share the future profits equally. This is a reconstitution of the firm where the number of partners and their profit sharing ratio both have changed.
3. Admission of a Partner
When a firm requires additional capital or managerial help it can admit a new partner in its business. As per the Partnership Act, 1932, a new partner can only be admitted unanimously unless otherwise provided in the partnership deed. When a new partner is admitted a new agreement is formed and thus the firm is reconstituted.
The new partner acquires the right to share the assets of the firm for which he brings in the capital and the right to share the future profits of the firm for which he brings Goodwill. On admission of a new partner, the profit sharing ratio changes, the assets and liabilities are revalued and goodwill is calculated and distributed among the old partners in their sacrificing ratios.
4. Death or Insolvency of a Partner:
Death or insolvency of a partner also results in the reconstitution of the firm when the remaining partners wish to continue the firm. In case of insolvency, all dues are paid to the insolvent partner and partnership agreement is aborted because as per the law an insolvent is incompetent to enter into a contract or an agreement.
In case of death, all dues are paid to the legal heir of the deceased partner.