Addition and Removal of Partners

Addition and Removal of Partners

Guides » Partnership Firm » Addition and Removal of Partners

Addition and Removal of Partners

Any slight changes made in the relationship between partners in a partnership firm would result in the reconstitution of the firm itself. Thus, whenever a new partner is introduced or when an existing partner is being removed, a partnership firm is bound to be reconstituted. Therefore, subject to a contract between partners and the provisions regarding minors in a firm, no addition or removal of a partner can be initiated without the consent of all the existing partners. This article talks about the legal consequences of Addition and Removal of Partners in a Partnership Firm as stated in the Indian Partnership Act of 1932.

Section 31: Introduction of a new partner

It is a basic rule of partnership incorporation that the introduction of a new partner into the partnership firm has to be backed up by the knowledge and consent of the existing partners.

Rights and Liabilities of a New Partner

The liabilities of a new partner in a partnership firm generally commences from the date when the individual is admitted as a partner unless he agrees to be liable for obligations incurred by the firm before the date. The new firm, including the newly introduced partner who joins it, may agree to assume liability for the firm’s existing debts, and creditors may decide to accept the new firm as their debtor and discharge the old partners. The consent of the creditor is necessary in every case to make the transaction operative. Novation is the technical term in a contract for substituted liability, of course, not confined only to the case of a partnership.

But a simple agreement among the partners cannot operate as Novation. Thus, an agreement between the partners of the firm and the incoming partner stating that he shall be liable for existing debts will not ipso facto give creditors of the firm any right against him.

In the case of a partnership between two partners, this section does not apply as the partnership automatically dissolved by the death of one of them. In this event, there is no partnership at all for any new partner to be introduced into it without the consent of other.

Section 32: Retirement of a partner

An existing partner of a partnership firm may retire while fulfilling the following conditions.

  1. Obtain the consent of all the other partners of the firm.
  2. By an express agreement among the partners.
  3. By submitting a notice in writing to all the partners regarding the intention to retire if the partnership is formed at will.

However, such a partner shall continue to be liable to the third party for the acts of the firm after his retirement unless public notice of the withdrawal has been published by himself or by the other existing partners. Although, as stated in Sub-sections (3) and (4), the retired partner will not be liable to any third parties if the latter deals with the firm without knowing that the former was a partner.

Rights of the outgoing partner

The following are the rights of an outgoing partner.

Section 36: Right to conduct a competing business

An outgoing partner may carry on a company that competes with that of the firm. The partner may advertise such activity, but subject to contract to the contrary, the partner, cannot use the name of the firm or represent himself as carrying on the business of the firm. This includes soliciting customers of the firm that he has left as stated in Section 36(1). Although this provision has imposed a few restrictions on an outgoing partner, it effectively allows him to carry on a business activity competing with that of the firm. However, the partner may agree with his partners that on his ceasing to be so, he will not carry on a business activity similar to that of the firm within a specified period or prescribed local limits. Such an agreement will not be restraint of trade if the limitation is reasonable as stated in Section 36(2).

Right to Shares

When a partner retires, he has the right to obtain or receive his share of the firm’s property that includes goodwill. The assets or the properties should be taken at their fair value to the partnership firm at the date of the account and not at a value as appearing in the partnership if it has been held that in the absence of evidence of any uniform usage to the contrary.

Section 37: Entitled to claim

If the continuing partners carry on the business of the firm with the property of the firm without a final settlement of accounts with the exiting partner, then the outgoing partner is entitled to claim from the firm. The partner may claim from the firm such share in the profits made by the firm, as he ceased to be a partner, as attributable to the use of share of the property of the firm. Another option for the partner is to claim interest at 6 per cent per annum rate on the amount of the partner’s share in the firm’s property.

However, if through a contract between the partners, and has been provided to the continuing partners, to purchase the interest belonging to the outgoing partner, the outgoing partner or his estate will not be entitled to any further share of the profits if the option is duly exercised. On the other hand, a partner who assumes to act in exercise of the option does not in all material respect comply with the terms thereof; then the partner would be liable to account under the provisions under the Section.

Liabilities of the outgoing partner

The following are the liabilities of a partner who is leaving the partnership firm.

Section 32(3) and (4): Liability to the third party

As stated earlier, a retiring partner of a partnership firm continues to be held liable to a third party for the actions of the firm even after his retirement, until a public notice regarding the retirement has been published either by himself or the other existing partners. However, the retired partner shall not be liable to any third party if the latter has dealings with the firm without the knowledge that the former was a partner.

Section 32(2): Agreement of Liability

The retired partner is liable to a third party until a public notice of retirement is published. As regard to the liability for the acts of the firm done before his retirement, the retiring partner shall remain liable for the same unless an agreement exists between him, the partners of the firm and the concerned third parties. This sort of a deal may be implied by a course of dealings between the third party and the reconstituted firm after he knew about the retirement.

If the partnership is formed at will, the partner will be deemed to be relieved as a partner without giving public notice to this effect by giving notice in writing to all the other partners of the firm of his intention to retire.

Section 33: Expulsion of a partner

There are various reason why a partner may be expelled from a partnership firm. A partner of a firm may not be dismissed from a partnership firm by a majority of the partner except in exercise, in good faith, of powers conferred by contract between the partners. An expulsion is not deemed to be in a proper interest of the business of the firm if the conditions below are not fulfilled.

  1. The power of expulsion must be stated in a contract between the partners.
  2. A majority of the partners must exercise the power.
  3. It has to be exercised in good faith.

The test of good faith as required for expulsion as stated under Section 33(1) includes three aspects.

  1. The expulsion must be in the best interest of the partnership.
  2. The partner that is to be expelled must be served with a notice.
  3. The partner has to be given the opportunity of being heard.

If a partner is expelled without fulfilling these conditions, the expulsion is considered null and void. The only solution, when a partner is involved in misconduct in the business of the firm, is to seek judicial dissolution. It should be noted that the expulsion of partners does not always result in the dissolution of the firm. An invalid expulsion of a partner does not bring the partnership to an end even if the partnership is at will and it will be deemed to continue as before.

Section 34: Insolvency of a partner

When a partner of a partnership firm is adjudicated an insolvent, the partner ceases to be a partner on the date of the order of adjudication regardless if the firm is dissolved or not. The partner’s estate ceases to be liable for any action of the firm taken after the date of the order, and the firm is also not responsible for action taken by the partner after the said date.

Effects of Insolvency

The effects of Insolvency have been listed below.

  1. The partner cannot continue as one in the firm after being insolvent.
  2. The partner ceases to be a partner from the date on which the order of adjudication is made.
  3. The estate of the insolvent partner shall not be liable for the actions of the firm taken after the date of the order of adjudication.
  4. The firm is similarly not liable for any action taken by the insolvent partner after the date of the order of adjudication.
  5. Generally but not invariably, the partner’s insolvency often results in the dissolution of the firm. However, the partners are competent to agree among themselves that adjudication of a partner as an insolvent will not give rise to a dissolution of the firm.

Section 35: Death of a partner

In a case where under a contract that the death of a partner does not dissolve a firm, the estates of the deceased partner are not liable for any act of the firm after his death.

Generally, the effect of the death of a partner would result in the dissolution of the partnership. Although the rule in concern to the dissolution of the partnership due to death of a partner is subject to a contract between the parties and the partners are competent to agree that the death of a partner will not have the effect of dissolving the partnership. This is applicable unless the firm consists of just two partners. It is not essential to give any notice either to the public or the individuals who have dealt with the firm about the estate of the deceased partner may be absolved from liability from future obligations of the firm.

Section 38: Continuing Guarantee Revocation

A continuing guarantee is given to a firm or a third party in concern of a transaction of a firm is revoked as to future transactions from the date of any amendments made in the constitution of the firm. This provision is given in Section 38 of the Indian Partnership Act in the absence of an agreement to the contrary. It should be noted that this rule is subject to an agreement to the contrary. The agreement, if any made, to the contrary required to displace the effect of Section 38, must be stated clearly and should be precise.

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