Everything you need to know about the partnership form of business. The need for partnership form or organization arose from the limitations of sole proprietorship and joint hindu family firm.
With the expansion of business, it became necessary for a group of person to join hands together and supply necessary capital and skill. A person may possess exceptional business ability but no capital; he can have a financing partner.
Section 4 of Indian Partnership Act of 1932 defines partnership as “the relation between person who has agreed to share profits of a business carried on by all or any of them acting for all.”
Owners of the partnership business are individually called partners can collectively called a “firm”.
Learn about:- 1. Definitions of Partnership Firm 2. Characteristics of Partnership Firm 3. Suitability 4. Advantages 5. Disadvantages 6. Kinds of Partners 7. Rights, Duties and Liability of Partner 8. Partnership Deed 9. Limited Liability Partnership.
Partnership Firm: Definitions, Characteristics, Kind of Partners, Suitability, Partnership Deed, Advantages and Disadvantages
Partnership Firm – Definitions, Advantages, Disadvantages, Suitability, Kinds of Partner, Partnership Deed, Duties of a Partner and a Few Others
We understood that a proprietary form of business is faced with many limitations. There is a limit to the amount of money that can be invested by a businessman in a business. The amount of strategic thinking that he/she can do is also limited. As such, sole proprietary businesses are usually small. Partnership form of business removes these limitations and allows the business to grow.
Partnership is an association of two or more persons to carry on a business in the capacity of co-owners. Each such person is called a partner. All the partners share the profits and losses in proportion of their respective ownership, or as agreed between them.
The amount of money that can be committed by a partnership firm is much larger. This is possible because each partner can bring in a part of the total amount of capital required rather than only one person arranging the money. There are more people to take care of different functions of the business (such as Marketing, Finance, Production, etc.). Thus business can be managed better. However, decision making is collective. There is a need to involve and convince other partners before any decision can be taken.
A partnership can be formed either orally or in writing. There is a limit on the number of partners who can start an enterprise together.
According to the Oxford Dictionary for the Business World. “Partner is a person who shares or takes part in activities of another person. Partnership is an association of two or more people formed for the purpose of carrying on a business”
According to Prof. L. H. Haney, “Partnership is the relation existing between persons competent to make contracts, who agree to carry on a lawful business in common, with a view to private gains.”
In the words of Prof. Macnaughton, “Partnership results from the desires of business to take advantages of complementary ability and to raise more capital”
“Partnership is the relation which subsists between persons, who have agreed to combine their property, labour or skill in some business and share the profits thereof between them” -Indian Contract Act, 1872.
“It is the relation between persons who have agreed to share the profits of a business carried on by all or anyone acting for all”. – Section 4 of Indian Partnership Act, 1932.
“Partnership is an association of two or more persons who carry on as co-owners, a business for profit” – Uniform Partnership Act, U.S.A
Advantages of Partnership:
i. Ease of Formation:
Any two persons capable of entering into contract can start partnership. The partnership deed can be oral or written. Registration is not compulsory. Thus, partnership is very easy to form. However, business conditions or requirements may force partnerships to be formed through a partnership deed, which is in writing. For example, banks may not allow a partnership firm to open a banking account unless there is a written partnership deed.
ii. Flexibility of Operations:
There is considerable freedom in carrying out business operations. There is no need for taking approvals from Government or any other authority, to change the nature, scope or location of the business.
iii. Greater Financial Resources:
Partnership combines the financial strength of all partners, as the liability of partners is joint and several. Not only is the ability to contribute capital greater, it also enhances the borrowing capacity of the firm.
iv. Greater Managerial Resources:
Partnerships are often formal by people looking for advantages of synergy. If one partner has technical knowledge, other could be marketing or finance expert. Thus, the managerial resources of the firm are enhanced. The financial resources available with the firm enables the firm to employ a good manager on salary basis for taking care of the business in a professional manner.
v. Greater Creditworthiness:
When a lender evaluates the proposal for loan, he looks at the creditworthiness of the borrower. A partnership firm, by definition, has more than one person responsible for the business. All partners are jointly and severally liable for the debt taken by the firm. The personal assets of all the partners can be used for repayment of the loan. All this gives greater confidence to the lenders. Thus, a partnership firm enjoys greater creditworthiness and therefore raise more debt for the business.
vi. Balanced Judgement:
In a partnership, the day to day management might be taken care of by one or few partners. However, in case of major issues, partners are likely to discuss the circumstances and arrive at a balanced judgement. Decisions are unlikely to be taken in haste, or in emotion.
Partnership can benefit from division of labour. Partners may choose to specialise in an area of interest. Partners can clearly define responsibilities and duties amongst themselves. This will result in expertise in management, apart from increase in efficiency, thereby maximising profits.
viii. Maintenance of Secrecy:
A partnership firm is a closely held business. It is not required by law to share its performance and position with others. Thus, all knowledge about the firm is restricted to only the partners of the firm.
ix. Personal Contacts with Staff and Customers:
A partnership concern is a relatively small organisation, whose activities can be managed by a group of people. Thus, partners keep in close contact with customers and staff. They are thus able to note the changing tastes and attitudes and react faster to such changes.
x. Economies in Management:
Partners have a stake in the profits of the business. They ensure that wastage is kept at the minimum. All expenses are closely supervised. Thus, expenses of management are controlled.
xi. Conservative Management:
Partners have unlimited liability. Unlimited liability prevents the partners from taking reckless decisions. They not only ensure that the decisions taken by them are acceptable to all, but also confirm that no other partner is acting needlessly aggressive.
xii. Protection of Minority Interest:
A partner being jointly and severally liable for any action of the firm, he has a right to stop the firm from taking action that is not in the interests of the firm. Such a partner cannot be ignored even if majority of partners feel otherwise. Decisions of partnership need the consent of all partners.
xiii. Incentive to Hard work:
Partners have share in the profits of the firm. Partners put in hard work and try to increase profits of the firm. A sincere and committed effort brings in extra rewards.
xiv. Risk Reduction:
The profits and losses are shared by all partners. Similarly, if the firm is unable to meet any of its payment obligations, all partners are responsible. Thus, partnership offers risk reduction as the risk is spread across partners.
xv. Greater Scope for Expansion:
As number of partners is larger, the firm can plan for faster expansion. It can also have geographical expansion, as a partner can be mobile and sufficiently experienced to handle the organisational activities from a new place.
xvi. Easy Dissolution:
It is very easy to dissolve the partnership firm. Any partner can ask for dissolution of firm by giving a 14 day notice. The firm can be dissolved on death, insolvency or lunacy of any partner. No legal formalities are required.
The Income Tax Act, 1961 treats a Partnership as a separate ‘person’ and its tax is calculated separately. This allows scope for partners to do tax planning and reduce total tax payable to minimum.
Disadvantages of Partnership:
i. Unlimited Liability:
Partners become fully liable for all claims against the firm to an unlimited extent. The partner might lose all the savings of his life on account of a loss or a mistake in business. This is one of the reasons that the selection of a partner or association with a like-minded partner is the most important thing in forming a partnership business.
ii. Restriction on Transfer of Interest:
One of the golden rules of any investment is that there must be an easy exit. If partner needs money, or is not in agreement with others, he cannot transfer his interest in the firm to outsiders without the consent of outsiders. A partner will not be able to reduce or increase his stake in the partnership.
iii. Inadequacy of Capital:
The number of partners in a firm is restricted to a maximum of twenty persons. Thus, a partnership firm may not be in a position to raise the required capital to finance its expansion plans. Hence, businesses that need large amounts of capital are generally organized as Joint Stock companies. For example, an oil refining business like Reliance Industries Limited or a car manufacturing business like Tata Motors Limited, cannot be imagined as Partnership firms.
iv. Mutual Conflicts:
Partnership requires close cooperation and a lot of understanding amongst partners. If there is a serious difference of opinion amongst partners, with different partners trying to pursue different goals then it is not good for the health of the business. Friction between partners will eventually lead to closure of business.
v. Uncertain Continuity:
Partnership may be dissolved on account of death, insolvency, insanity or incapacity of any of the partners. There is always a serious threat to continuity of business in its existing form. Hence, partnership firms are not suited to businesses requiring long term capital and plans.
vi. Delay in Decision Making:
While day to day management is handled by one or more partners independently, any major decision requires the consent of all partners. A discussion and consensus on decision to be taken might be time consuming, resulting in the firm losing out on prompt action.
vii. Risk of Implied Authority:
A partner can bind all other partners of the firm by his actions. This is a great risk to the other partners, as any hastily taken action may result in wiping out the life savings of all partners. It is seen that mistrust and wrong decisions by managing partners usually lead to dissolution of partnership firms.
viii. Lack of Public Confidence:
The affairs of the firm are not subject to public scrutiny. The performance and position of the firm is not published. Hence, the firm does not enjoy any public confidence.
ix. Aversion to Risk:
The liability of all partners is unlimited. Also, the partners are jointly and severally liable. In other words, a wrong step taken by one partner can result in all or some of the partners becoming bankrupt. Keeping this in mind, partners have a very high aversion to risk.
x. Limited Scope for Expansion:
A partnership firm can have only a limited number of partners. The liability of these partners is unlimited. Therefore, their ability to take risk is limited. This limits the ability of the firm to expand and grow.
xi. Continuation of Responsibilities:
Normally, the responsibilities pertaining to a business end with closure of the business. However, in case of Partnership firms, unless the liability of the firm is limited (LLP or Limited Liability Partnership), the responsibility of partners continues even after the firm is closed down (dissolved). This continues till the claims of all outsiders are completely settled.
xii. No Independent Legal Status:
Partnership firm is not separate or distinct from its members. It does not have a separate legal entity of its own. Partners enter into contracts on behalf of each other.
Suitability of Partnership Form of Business:
Sole proprietorship is suitable for businesses which are relatively small, require small amounts of capital, risks ate not high and decision making needs to be quick. However, as the size of the business grows, the business needs different types of skill-sets to carry out its different functions.
It needs more capital and multiple things need to be done simultaneously. For example, customers need to be attended to and at the same time, a bank loan may have to be negotiated. Thus, as enterprises grow large, a Partnership form of business might be more suitable for small and medium sized businesses.
Partnership form of business has its own advantages and disadvantages. However, many a times, it is most suitable form to run a small business.
Some such instances are listed below:
a. In case of businesses where the capital requirement is medium i.e. it is neither too large nor too small. Business like retail and wholesale trade or small manufacturing units can be successfully started by partners.
b. Businesses that need different ability, managerial talent, skill and expertise are best run in Partnership mode. For example, businesses such as Construction, Legal firms etc. prefer Partnerships where each partner contributes the best as per his specialization.
c. Family Businesses are best organized as partnerships wherein Husband and Wife, Parents and Children, Brothers and Sisters can become partners of a firm.
d. Businesses requiring flexibility of operations, wishing to avoid elaborate compliance requirements will prefer Partnership form of business.
Kinds of Partners:
i. Active or Working Partner:
A Partner who contributes capital to the firm and also takes active part in the day to day operations of the business is called an ‘Active’ or ‘Working’ Partner. Such a partner might be paid additional remuneration in the form of ‘salary’ for the work done by him. The day to day business decisions are taken by the Active Partner(s).
ii. Dormant or Sleeping Partner:
A dormant partner does not take part in the activities of the business. He merely contributes capital to the business and shares the profits earned by the firm. However, he is entitled to all the rights of a partner and is liable for all the acts of the firm and other partners.
iii. Nominal Partner:
A Nominal partner is a person who lends his name and reputation to the partnership. He neither contributes capital to the firm, nor takes active part in the activities of the business. He is not entitled to any benefits accruing to a partner of the firm. However, he is liable to outside parties for the claims against the firm.
iv. Partners in Profits Only:
A person who becomes a partner on the specific understanding that he shall get a share in the profits of the firm, but shall not share any loss sustained by the firm. However, even such a partner is liable for claims against the firm. Usually, such partners contribute their reputation and goodwill to the business. They may or may not take active participation in the day to day operations of the business.
v. Partnership by Estoppel:
‘Partner by Estoppel’ is not a partner of the firm. However, by his behaviour, talk, etc., he creates an impression in the minds of outsiders that he is partner in the firm. He is not entitled to any benefit that may accrue to a partner of the firm. However, he is liable to the outsiders for claims against the firm, as the outsiders might have extended credit to the firm on the firm on the belief that such a person is a partner of the firm.
For example, A, B and C are three brothers. B and C are carrying on a small business. D is a close friend of A, A gives an impression to D that he is partner in the business of B and C. D gives a loan to the firm, which is not recoverable. D can claim the money from A as he gave the loan under the impression that A is a partner. He would not have given the loan, if he knew that A is not a partner. Thus, A is liable to ‘D’ and is estopped (prevented) from denying liability on the ground that he is not a partner.
vi. Partner by Holding Out:
If a person is projected as a partner of the firm and the person does not deny it, then he becomes a partner by Holding Out. ‘Partner by Holding Out’ also is not a partner of the firm. However, he is also liable for all the claims made on the firm by third parties, as they might have given a credit to the firm on the belief that such person is a partner.
For example, X, Y and Z are three brothers. X is a highly successful businessman. Y and Z are carrying on a small business in partnership. In a party, Y introduces X to M as his partner. X does not deny it, although he does not expressly state that he is a partner. M gives loan to the firm, which is not recoverable. M can recover the loan from X. X is a ‘Partner by Holding Out’.
vii. Quasi Partner:
Quasi partner is a person who is no longer a partner of the firm, but creates an impression that he continues to be a partner of the firm. Since he has retired from the firm, he neither takes part in decision making, nor share profits of the firm. He does not have any capital in the firm. However, since he creates an impression that he is continuing as partner, his liability is unlimited.
viii. Secret Partner:
Secret partner is a partner of the firm but does not wish to be known as partner to outsiders. However, he is entitled to all the rights of a partner and is liable for all the claims on the firm. The fact that outsiders have extended credit to the firm without knowing that he is a partner cannot be used as a defense either by the partner or the firm.
ix. Limited Partner:
He is a partner whose liability is limited to his contribution to capital. Thus, in the event of any loss, such a partner will lose only the capital invested by him. In other words, his private assets are protected.
x. Sub Partner:
Sub partner is not a partner of the firm. In fact, he has nothing to do with the firm. For the firm, such a person does not exist. A sub partner is a person who has an agreement with one of the partners of the firm to share his profits/ losses from the partnership firm. It is a private agreement between the partner and sub partner.
For example, let us say, A and B are partners in a firm sharing profits and losses equally (each partner gets 50%). A and his wife, Mrs. A enter into an agreement that A shall share all his profits (and losses) from the partnership with her in the ratio of 3:1. Accordingly, Mrs. A pays 25% of the capital contributed by A in the partnership firm. Neither B nor the rest of the world is aware of the agreement between A and his wife. Mrs. A is then a sub partner.
A sub partner does not have any liability towards the firm. He or She may not even contribute capital. The rights and obligations of the sub partner are driven by the agreement with the main partner.
xi. Minor as a Partner:
A minor is a person who has not yet attained the age of majority, which is 18 years. A ‘Minor’ does not enjoy the capacity to enter into contracts in his own. Since Partnership is a contractual relationship, a minor cannot become a partner.
As per the Indian Contract Act, a minor cannot enter into a contract and if any such contracts have been entered into, then such contracts are void. However, he can be admitted into the benefits of Partnership, with the consent of all partners of the firm.
The following are the rights and liabilities of a minor, who is a partner:
(a) A minor has a right to the share of the profits and property of the partnership, as per the agreement between the partners.
(b) He can inspect the books of accounts of the firm.
(c) The liability of a minor is limited to his share of capital in the firm. He is personally not liable for any wrong doings by the firm and his personal property will not be attached while paying the liabilities of the firm.
(d) A minor cannot sue the other partners for payment of his dues in respect of his share in the profits of the firm. However, if he decides to leave the partnership, then he can sue the other partners for payment and final settlement of his dues relating to his partnership share.
(e) A minor, within six months of attaining majority, shall decide whether he wants to continue as a partner in the business or leave the partnership. He shall do this by giving a public notice regarding his decision. However, if he fails to give a public notice regarding his decision or if he fails to decide within six months of attaining majority, then he shall become a partner.
(f) If a minor decides to become a partner then he shall be liable for all acts, debts and obligations of the firm, since the date of his admission into benefits of partnership of the firm. His personal assets shall be used to repay the liabilities of the firm, if required.
(g) If he decides not to become a partner, he shall not be liable for any acts of the firm after the date of issue of notice.
Formation of Partnership – Partnership Deed:
A Partnership is formed by two or more persons who enter into an agreement to carry on business. This agreement may be oral or in writing. However, it is always preferable to have the agreement in writing, so that possibility of any misunderstanding in future is avoided. If all important terms and conditions regarding the partnership business are agreed upon, put in writing and signed by all partners, such agreement is called ‘Partnership Deed’.
The terms and conditions contained in the Partnership Deed are called Articles of Partnership. Partnership Deed mainly contains details regarding internal management as well as relations with external parties such as debtors and creditors. It should be properly stamped as per the provisions of Indian Stamp Act, signed by all parties and a copy of the deed should be kept by all the partners.
The rights, duties and liabilities of partners can be inferred from the ‘Partnership Deed’. Only when the ‘Partnership Deed’ is silent in respect of any issue, the provisions of Partnership Act are involved.
Contents of Partnership Deed:
The following aspects are normally covered in the partnership deed:
i. Name of the firm
ii. Names, addresses, qualifications and occupations of partners.
iii. Nature and Scope of Business proposed to be carried on by the firm.
iv. Objects of the firm. (The word “Objects” is used to mean “objectives” or purpose.)
v. Duration of Partnership, if any.
vi. The place where business is proposed to be carried on.
vii. Amount of capital to be contributed by each partner.
viii. Amount that can be withdrawn by a partner from the business.
ix. The rate of interest that shall be payable to partners on their capital.
x. The extent to which each of the partner would be involved in the day to day management of the business
xi. The rate of interest that shall be charged to partners on withdrawal of capital from the business.
xii. The ratio in which partners shall share the profits or losses.
xiii. The amount of salary or commission payable to any partner for any services rendered to the firm.
xiv. Allocation of responsibilities of business amongst various partners.
xv. Maintenance of Books of Account of partnership firm
xvi. Process for audit and Inspection of Accounting books by a partner.
xvii. Matters pertaining to admission or retirement of a partner.
xviii. The method of valuation of Goodwill at the time of admission / retirement of partners.
xix. The method of revaluation of assets and liabilities on admission retirement or death of a partner.
xx. Loans and Advances given to the firm by the partners and the rate of interest that shall be payable.
xxi. Procedure of Dissolution of the firm and mode of settlement of accounts after dissolution.
xxii. Arbitration clause for settlement of disputes, if any, between partners.
xxiii. The conditions for expulsion of a partner and procedure for expulsion.
xxiv. Arrangement in case of insolvency of a partner.
xxv. The rights, duties and obligations of partners.
xxvi. Operation of Bank Accounts and authority for signing Cheques and other documents.
xxvii. Any other clause or clauses that may be desired by the partners to be included in the Deed.
Rights, Duties and Liabilities of a Partner:
The Partnership Deed contains details of rights, duties and liabilities of a Partner. If there is no partnership deed, or the deed is silent on any aspect, the provisions of Partnership Act come into force.
Generally, the rights, duties and obligations of a partner are as under:
Rights of a Partner:
i. To take part in management of business of the firm.
ii. To express his opinion on any matter concerning the firm.
iii. To vote on any issue requiring consent of atleast a majority of partners
iv. To access, inspect and maintain a copy of books of account of the firm.
v. To share profits of the firm as per agreement.
vi. To receive interest on loans advanced by the partner to the firm. If rate of interest is not fixed, it is calculated @ 6% p.a.
vii. To receive any amount spent by him/her in the proper conduct of business of the firm.
viii. To be indemnified for any loss incurred in the conduct of business of the firm.
ix. To remain as partner of the firm, unless expelled from partnership as per the Partnership Deed. For example, a partner cannot be expelled from the partnership simply by majority vote of other partners.
x. To retire from the partnership as per the norms agreed upon.
xi. To have the property of the firm used exclusively for the purpose of the firm.
xii. To accept or reject the admission of a new partner.
xiii. To be a joint owner of all the assets of the firm.
xiv. To issue a notice for dissolution of the firm.
xv. To carry on a business competing with the business of the firm, on retirement.
xvi. To share profits, or earn interest @ 6% p.a., on amount due to partner on retirement, until the payment is made in full.
xvii. To do all or any act necessary to protect the firm from loss in case of an emergency.
Duties of a Partner:
i. To be just and faithful to the firm and the other partners.
ii. To provide full and correct information and true accounts of the firm to each other.
iii. To carry on business of the firm to the maximum advantage of the firm and all the partners.
iv. To share profits and losses of the firm as per agreed terms.
v. To try and protect the firm from loss to the best of his ability.
vi. To indemnify the firm against any loss caused by his gross negligence, breach of conduct or willful misconduct in the ordinary course of business.
vii. Not to carry on any business that competes with that of the firm in any manner.
viii. To handover any profit made from a business in competition with business of the firm, to the firm.
ix. Not to use any of the assets of the firm for his personal use or for use in a business other than the business of the firm.
x. To act within the scope of his authority.
xi. Not to transfer or assign his interest in the partnership to another person without the consent of other partners.
xii. Not to earn any secret profit by way of commission on sales or purchase etc., on any dealings done on behalf of the firm.
Liabilities of a Partner:
i. All Partners are jointly and severally liable for all acts of the firm. If the assets of the firm are not sufficient to satisfy the claims of outsiders, such claims can be recovered from the personal assets of any one, some or all partners.
ii. A partner is liable to make good any loss caused to the firm due to his negligence or misconduct in the ordinary course of business.
iii. A partner is liable for any act of the other partners acting within the scope of his authority.
iv. A partner is liable for any profit made on account of dealing on behalf of the firm, to the firm.
v. A Partner is liable for any profit made by a business, competing with the business of the firm, to the firm.
vi. A partner is liable for any profit made by putting the assets of the firm to personal use.
vii. A partner is also liable to any third party for any wrongful act done by such partner, or any other partner of the firm.
viii. A partner is liable for misuse of money of third parties received by the partner.
ix. A retiring partner is also held liable for all such acts of the firm contracted before the term.
Limited Liability Partnership (LLP):
A Limited Liability Partnership (LLP) is a body corporate which is a distinct legal entity separate from that of its partners. It has perpetual succession and a common seal. It has been designed so as to allow it to function like a normal partnership entity while at the same time offering the benefits of a body corporate.
LLP became a popular choice, particularly for professionals such as Chartered Accountants, Lawyers, Architects, etc. after the boom in the services sector. The LLP helps such professionals to forge partnerships and benefit from synergies between them, without becoming fully liable for acts of partners. While LLPs have existed in the USA, UK and other countries, it is a relatively new concept in India.
Essential Features of a LLP:
i. Body Corporate – LLP is a body corporate which has a separate legal existence from its partners.
ii. Separate Legal Entity – The LLP is a separate legal entity. It can own and hold property in its own name. It can sue and be sued by others.
iii. Limited Liability – The liability of all the partners in an LLP is limited to their respective shares in the partnership.
iv. Number of Partners – Any two or more persons can start an LLP there is no maximum limit on the number of partners.
v. Simplicity – LLP is not subjected to various statutory requirements such as meetings, resolutions, etc. Thus, the operation of a LLP is very simple.
vi. Perpetual Existence – A LLP can be formed either for a specified duration, for a specific job or for perpetuity. The LLP continuity is not impacted by a change in its partners. Resignation or Death of Partners does not result in dissolution of LLP.
vii. Perpetual Succession – The LLP will have perpetual succession but it can be wound-up if agreed by all the partners.
viii. Flexibility – The LLP can be formed for any business activity which is undertaken for profit. However, a LLP cannot be created for non-profit business or activity
ix. Registration – The LLP needs to be registered with the Registrar of Companies of a particular State. The business of the LLP can be carried out in any State of India irrespective of the State in which the LLP is registered.
x. LLP Agreement – The mutual rights, obligations, and duties of the partners have to be described in the LLP Agreement. The capital and profit sharing ratios of the individual partners need to be mentioned in the LLP Agreement. The rules and procedures regarding induction and removal of partners need to be specified in the LLP Agreement. In the absence of an agreement on some clauses, the clauses under the LLP Act and the associated rules and regulations shall apply.
Limitations of a Partnership Form of Organisation:
Traditionally, partnership form of organisation has been very popular in a country like India and the world over.
However, it suffers from the following limitations:
i. The maximum number of partners cannot exceed 20.
ii. The liability of the partners is unlimited.
iii. Acts of a single partner binds both the partnership firm and other partners, irrespective of whether the acts are ratified by all the partners or not.
iv. Challenges in raising capital from banks and other institutions.
v. Lack of transparency among partners.
While the Company form of organization can remove these hurdles, the reason for absence of corporate form the high compliance costs. The Limited Liability Partnership (LLP) form of organisation addresses the weakness of the partnership form of organisation by giving it a corporate structure similar to that of joint stock companies.
At the same time, it provides the required flexibility in management similar to that of partnership organisations. Accordingly, the LLP form of business organisation was introduced in India by way of Limited Liability Partnership Act, 2008 (LLP Act 2008) which came into effect by way of notification dated 31st March 2009. It is applicable to the whole of India.
Partnership Firm – Definitions and Characteristics (With Scope for Sole Proprietorship and Partnership)
The individual proprietorship organisation with all its limitations, proved unequal to the requirements of expanding business. Expansion of business called for more capital, enhanced the risk, and required more managerial ability than could be expected of a single individual.
A wealthy man may lack of managerial capacity, and an able manager might not have money enough to finance a big concern. This made some kind of an association among individual businessmen necessary. Partnership organisation is one form of such association. It grew essentially out of the failures and limitations of the individual proprietorship and represents the second stage in the evolution of the forms of business organisation.
Generally, when a sole trader finds it hard to cope with the problems created by the expansion of business, he takes an able employee, or some other capable and well-to-do person, as his associate in business and converts his sole-proprietary business into a partnership.
The formation and management of partnership organisation is governed by the provisions of the Indian Partnership Act of 1932. Section 4 of “the Act defines partnership as the relation between persons who have agreed to share profits of a business carried on by all or any of them acting for all.”
The following characteristics of partnership emerge from this definition:
1. Existence of business – An association of persons will become a partnership only when it is meant to do some kind of business. If the purpose is to carry on some charitable work, it will not be a partnership.
2. Plurality of persons – At least two persons must join together for business. One person cannot enter into partnership with himself.
3. Contractual relationship – The business is set up by an agreement between persons concerned called partners. Persons who are not competent to contract (e.g., minors) cannot be partners. Moreover, a Hindu family business does not automatically become a partnership business.
4. Profit motive – The purpose of partnership should be to earn profits and there must be an agreement to share them.
5. Principal-agent relationship – The business must be carried on by all or one or more acting on behalf of all the partners. Thus, every partner is an agent of the other members of the firm.
All these conditions must be satisfied to constitute partnership. If the manager of a firm is given a share in profits, he is not be treated as a partner, because business is not carried on his behalf. The chief test of whether a person is a partner or not is whether the business is conducted on his behalf, i.e., whether or not the element of agency exists. Every partner has the right to participate in the management of the firm’s business though any of them may give up this right by agreement.
The minimum number of persons required to make a partnership is two. The Partnership Act does not mention the upper limit but under the Companies Act., 1956, a partnership consisting of more than 20 persons for a general business and 10 partners for a banking business would be illegal. Hence, these should be regarded as the maximum limits to the number of partners in a partnership firm.
It will be useful here to take notice of some other notable features of partnership organisation also:
1. Unlimited liability – Each partner has an unlimited liability in respect to the firm’s debts. The creditors can recover their dues from the property of any or all partners in case the firm’s assets are insufficient.
2. Utmost good faith – A partnership agreement rests on utmost good faith. The partners must, therefore, be just and honest to one another. They must disclose every information and present true accounts to one another.
3. Implied agency – Every partner has an implied authority to act on behalf of his fellow- partners and the firm in the ordinary course of business. Thus, he is an agent of the firm and the other partners.
4. Restriction on transfer of interest – A partner cannot transfer his share to an outsider without the consent of the other partners. This is so because partnership is a contract between individual partners and contract resting on utmost good faith at that.
Scope for Sole Proprietorship and Partnership:
Doubts are often expressed about the suitability of these forms of organisation in the face of keen competition offered by corporate enterprises which have certain important overriding advantages of economic viability, organisational and operational efficiency and freedom from the discouraging feature of unlimited liability.
These doubts are not justified in practice in view of the following factors:
1. Most often business is initially started as a sole proprietorship or partnership concern and converted into Joint Stock Company when it is economically viable and financially attractive for investment by the general public.
2. Barring production in most other fields like trading, wholesale and retail (with the exception of import and export trade), factors like economic viability, direct motivation, personal contact, need for servicing, etc., favour the organization of the business in the form of sole proprietorship or partnership.
In the field of distribution, these forms of organisation dominate the scene not only in India, but even in an advanced country like the United State of America where corporate form of organisation has made great progress.
3. Even in the field of production, despite rapid and great technological developments, there are a number of fields where the technical, managerial and marketing factors combine to keep the size of firms low and thus offer the best chance to sole proprietorship or partnership form of organisation to flourish.
4. Most of the service enterprises (like transport and warehousing services) are also organized as sole proprietorships or partnerships because of their small size. Further, in the case of professionals, like chartered accountants, lawyers, law requires that they should be organized only as sole proprietorship or partnership concerns.
Partnership Firm – Advantages and Disadvantages
The need for partnership form or organization arose from the limitations of sole proprietorship and Joint Hindu Family firm. With the expansion of business, it became necessary for a group of person to join hands together and supply necessary capital and skill. A person may possess exceptional business ability but no capital; he can have a financing partner.
A financier may need a managerial expert as well as a technical expert and all of them may combine to set up a business with common ownership and management. Thus partnership organization has grown out of necessity to arrange more capital, provide better management and control to take advantage of high degree of specialization and division of labor, and to share the risks.
Section 4 of Indian Partnership Act of 1932 defines partnership as “the relation between person who has agreed to share profits of a business carried on by all or any of them acting for all.” Owners of the partnership business are individually called partners can collectively called a “firm”.
The name under which the business is carried on is known as “firm’s name”. The terms and conditions of partnership are contained in the partnership agreement known as “Partnership Deed”.
(i) Easy Formation:
Formation of partnership is easier and no legal formalities are to be observed to establish it. At the same time, unlike a company, not much of expenses are incurred for its formation. However, as compared to sole trader’s concern, it may involve certain difficulties, especially in selection and organization of partners etc.
(ii) Larger Financial Resources:
In a partnership, since several people pool their financial resources into a common business, the amount of capital accumulation becomes much higher than what can be contributed by one person in sole trader’s concern. The scale of operations can be enlarged to reap the economies of scale. There is always scope for the introduction of new partners to augment resources.
It’s a highly flexible organisation. Changes can be introduced easily. The necessary additional capital can be raised, new partners can be introduced, and the pace and other object of the firm can be changed. Business of the firm can also be expanded or contracted according the requirement of the business.
(iv) Combined Abilities and Balanced Judgment:
In a partnership firm, better management of the business is ensured; because capital and brain of two or more persons are pooled. Combined abilities and balanced judgment produce appreciable results, two heads are better than one is an old saying.
(v) Direct Motivation:
Since the partners themselves manage the business, they are likely to manage it with great care, caution and interest. Moreover, partnership provides a fair correlation between rewards and efforts on the part of owners, and as such partners are motivated to apply the best of their energy and capacity fort the success of the business.
(vi) Division of Risks:
In sole proprietorship, the risks of business are to be shouldered by one person alone; but in partnership, the risks are to be shared by all the partners. Thus, partnership is more useful for a risky business.
(vii) Business Secrecy:
The annual accounts and reports of a partnership firm do not require circulation and publicity and, therefore, secrecy can be maintained about the business.
(viii) Protection of Minority Interest:
The Partnership Act provides equal rights and powers for all the partners irrespective of their capital contribution. Every partner has a right to participate in the management of the business. All important decisions are to be taken by the consent of all the partners. If a majority decision is enforced on minority, affected partners can get the business dissolved.
(ix) Encouragement of Mutual Trust and Interdependence:
Each partner is an agent for the others. Therefore, all the partners act with utmost mutual trust. They also develop a sense of interdependence and team spirit. At the same time each partners develops his individuality through his responsibility for others and the firm as a whole.
(x) Easy Dissolution:
A partnership firm can easily be dissolved: It is a kind of voluntary association for carrying on business operations, therefore, it can be dissolved by the partner merely by expressing to each other their intention to do so. In the case of partnership-at-will, it can be dissolved by giving 14 days’ notice to other partners.
(i) Unlimited Liability:
The partners, like a sole proprietor but unlike shareholders of a joint stock company, may be personally held liable for the debts of the firm. Their private property also remains at stake. Due to the danger associated with unlimited liability, partners are overcautious and play safe. This restricts the expansion and growth of the business.
(ii) Limited Resources:
There is an upper limit to the number of partners in a partnership firm-20 in a general business and 10 in a banking business. Due to this, in spite of the pooling of the resources by all the partners, it becomes difficult for a partnership to manage the increasing requirement of capital and managerial skills of expanding business. This limitation limits the growth of business beyond a certain size.
A partnership firm suffers from the uncertainty of duration; because it can be dissolved at the time of death, lunacy or insolvency of a partner. Sometime petty quarrels among the partners may also bring the partnership to an end. This discontinuity of the business is not only inconvenient to the consumers and works but is also a social loss.
(iv) Non-Transfer Ability of Interest:
Partners cannot transfer their interest in the partnership for to outsiders without the consent of all other partners. This non-transferability is a drawback of the partnership firm and dissuades many persons from investment in such a firm. On the other hand, shares of a joint stock company are easily transferable and, thus, provide liquidity to the investment.
(v) Lack of Public Confidence:
Since there is no publicity of the working of partnership through its published periodical accounts and there is absence of legal control over it, the general public may not have full confidence in them.
(vi) Risk of Implied Authority:
A partner, being an agent of the firm and his co-partners can make deals and contracts that would be binding on other partners. Therefore, when a partner is negligent or commits a wrong, or is guilty of a fraud, with the scope of his authority, other partners are equally liable financially without any limit. Thus, the honest and efficient partner may have to pay the penalty for follies and vices of other partners.
(vii) Lace of Central Authority:
The power of management is vested in all the partners; there is absence of a supreme central authority. Consequently, many problems crop up, particularly when there is absence of mutual understanding and cooperation. Constant opposition and disagreements on the part of partners hamper the growth of the partnership business at every stage and, ultimately, may even put an end to the existence of the partnership, after a short span of life.
When moderate amounts of capital, diversified managerial talents are needed, the partnership is an ideal choice of the form of business ownership. In general, partnerships work well in those areas where sole proprietorships work well, but a partnership is usually somewhat larger than a sole proprietorship, because there are more mouths to feed.
Partnership works out particularly well in the profession of law, medicine and accountancy. By sharing office and clerical expense, the partners effect considerable savings. Wholesale trade, retail trade, commercial farming, small scale industries, warehousing, transport service etc. are usually conducted through partnerships.
A partnership, however, will not function well in a very small business that cannot provide enough income to make association worthwhile. Nor is a partnership really adequate for very large enterprise, where the corporate form of ownership is more suitable.
Partnership Firm – Kinds of Partners, Advantages and Disadvantages
Like the sole proprietorship has centuries old history. The limitations and deficiencies of sole proprietorship and Joint Hindu Family Business led to the emergence of partnership as a form of business organisation. A partnership firm may be defined as “an association of two or more persons carrying business to share its profit.”
The Indian partnership Act, 1932 defines partnership as “the relation between two or more persons who have agreed to share profit of a business carried on by all or any of them acting for all.”
A partnership firm is an association of two or more persons to carry on a business as co-owners for profit.
A partnership firm is formed to combine capital, labour, managerial, technical and specialised skills or abilities to be used jointly with agreement to share profits or losses of the firm’s business. The person or individual entering into partnership agreement is known as ‘Partner’ and collectively as ‘Firm’ or ‘Partnership Firm’.
The name under which the business is to be carried on is called “Firm Name”. The terms and conditions of partnership are usually mentioned in the “Partnership Agreement .” known as the “Partnership Deed” A partnership firm does not have separate legal entity from its partners and has unlimited liability.
i. Active or Actual Partners:
A partner who takes an active part in the affairs of the firm’s business is called active, actual or ostensible partner. Such partner must give public notice of his retirement from the firm in order to free himself from liability for acts of the firm after retirement.
ii. Sleeping or Dormant Partner:
A sleeping or dormant partner merely invests his capital in the firm and does not take active part in the conduct of the partnership firm’s business affairs. He voluntarily surrenders this right and has no voice in its management. The firm generally does not disclose the existence of sleeping partners to the public in general. Such partner is not directly liable for any act of the firm and is not required to give public notice of his retirement from the firm.
iii. Nominal Partner:
A nominal partner does not give his contribution in capital. That means, no capital is contributed by him in firm’s business. He only lends his name or reputations of goodwill and credit to the firm. Because of his name, reputation and goodwill a partnership firm can attract additional business and fresh capital. Nominal partner never takes an active part in the management of the business, profit of the firm may or may not be given to the nominal partner. He is known to the outsiders as a partner of the firm. He is held liable to the third parties.
iv. Minor Partner:
A minor person can be admitted as a partner only to the benefits of the partnership firm. He can act as a partner even if he is a minor but he is incompetent to enter into a contract. Minor partner has limited liability to the extent of capital contribution. Within six month of attaining the age of majority, he has to give public notice of his desire to continue with the partnership firm or otherwise, he desires to continue he will be regarded as full- fledged partner with unlimited liability.
v. Holding Out Partner:
A person who represents himself or knowingly permit himself as a partner of the firm to the outside world by expressly or impliedly is called as holding out partner. Such a person shall be liable as a partner for the obligations created on the misrepresentation. He is not at all entitled to any rights of partnership. A holdings out partner is also called ‘Quasi Partner’ for he is not a partner in the full implications of the term. Only in the eyes of outside world, he is considered as a partner.
Basically such a person is not a partner in the firm, where exists no agreement, no sharing in profit and losses, no say in the management even not knowing the place of business but as he holds himself out to be partner he is liable to outsider for the firms act.
Advantages or Merits:
i. Larger Financial Resources:
Partnership firm enable to raise larger capital than sole proprietorship, because of more number of owners or partners. Their credit worthiness can also be used for borrowing larger sums of money. Because of higher capital investment the size of business operations of the firm is larger than sole proprietorship.
ii. Simple and Easy Formation:
Like the sole proprietorship the partnership firm can also be easily formed. Only formality is drafting and finalising partnership deed. Registration of the firm is not compulsory. Even, when desired, the procedure of registration is simple and inexpensive. Like sole proprietorship the partnership is also relatively free from legal formalities at the time of its formation.
iii. Integrated Ability and Judgment:
It is possible in partnership firm to integrate or combines the abilities, skills and judgment capacity of partners in the interest of the firm business. The affairs of the business can be managed effectively and efficiently, ultimately resulting in higher profits.
Flexibility is possible even in partnership as in sole proprietorship. According to changes taking place within and outside the firm, a partnership firm can easily be adjusted. Partnership firm ranks second in flexibility.
v. Quick Decision and its Implementation:
A partnership firm is able to take quick decision and can implement the same without delay because number of partners is small.
vi. Business Secrecy:
The business affairs and books of account of the partnership do not require publicity by law as is required in joint stock Company under the Companies Act 1956. The annual accounts need not be maintained in any prescribed form and auditing of accounts is also not required by law. Therefore, business secrecy can be maintained highly.
vii. Better Public Relation:
In a partnership firm every partner develops healthy and harmonious relationships with their employees, customers, suppliers, creditors, government authorities, auditors, etc. This relationship directly reflects in its accomplishment of objectives and higher profits.
viii. Survival Capacity:
Partnership firm can survive for a longer period or has long life in comparison to sole proprietorship. Partnership business need not come to an end on the death of a partner if the deed of partnership provides so. The same firm can undertake more than one line of businesses. Therefore, profits and losses in all these business can be adjusted.
ix. Assignment of Duties:
It is possible in partnership firm to assign duties to the partners according to the ability and interest of the partners. Partnership firm business may ultimately result in higher profits.
x. Simple and Easy Dissolution:
A partnership business can be dissolved as easily as it can be formed. It is a voluntary association. Therefore, it is simple to dissolve. A partnership-at-will can be dissolved by a partner giving 14 days’ notice to other partners.
i. Unlimited Liability:
Partnership form of business organisation is unsuitable for carrying on a large scale business or trading activity. Not only the business property of the partners is liable for the debts of the firm but private property of the partners is also liable to the extent of his private property not only for his own mistake and lapses but also for the mistakes, lapses and even dishonesty of his partner or partners. All the partners are jointly and severely liable.
ii. Limited Financial Resources:
The Partnership form of business organisation is incapable of providing the required capital because of maximum number of members cannot exceed 20 in ordinary business and 10 in banking business. When the partnership business grows in size and importance, further expansion becomes difficult for lack of fresh capital. This form of business organisation is not suitable for large size business which requires huge capital investment.
iii. Limited Organising Power and Technical Skill:
There are drastic changes in production and distribution system. Higher organising power and technical skills are required to cope with these changes. The partnership firms fail to provide both because of limitations on the organizing power as well as technical skills of the partners.
iv. No Separate Legal Status:
The partners of partnership firm do not have separate legal entity from the firms business. Partnership firm and partners are inseparable from each other. A partnership firms is terminable by death or insolvency of a partner. It has no stability whereas, a company enjoys stability since it has separate legal existence.
v. Non-Transferability of Interest in Firm:
The partnership share is not freely transferable. No partner is allowed to transfer his interest to an outsider without the unanimous consent of all other partners. But in public company shares are freely transferable from one person to another and they can be sold or purchased in the open market or stock exchange.
vi. Lack of Public Confidence:
In the absence of publication of account and in the absence of any strict legal control over the affair of partnership, it is said that, there is much less public confidence in partnership.
vii. Risk of Implied Authority:
The acts of reckless and incompetent partner are binding on other partner. A dangerous situation can be created when a partner becomes bankrupt because of the fault of other partner. A partner has implied authority to bind the firm by his acts of commission and omission. The firm may come into difficulty at any moment.
viii. Possibilities of Differences of Opinion:
Areas of disagreement among partners, are more than the chances of co-operations and mutual understanding. Many times there is a difference of opinion resulting in disputes amongst them. Jealousy and suspicion can arise which is not good for the well- being of partnership.
ix. Some Social Losses:
If a partnership firm is dissolved on any account, there is definite loss to the society both in terms of supply of goods and services and in terms of source of employment.