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Merits and demerits of a partnership firm with the requisites of ideal partnership
The article explains the meaning of a partnership business . It explains the various features of a partnership form of business and states the merits and demerits of a partnership form of business. It states the types and various kinds of partners . It states the requisites and the conditions of an ideal partnership. It also states the conditions when the partnership firm is dissolved and the contents of a partnership deed with the procedure for the registration of a partnership firm.
Meaning of a partnership A partnership can be defined as the association of two or more members (maximum 10 in case a banking business and 20 in other types), who have entered in either oral or written agreement to carry out a common business and share its profits and losses in equal ratio or as otherwise decided in the partnership deed.\
Features of a partnership firm
- Two or more persons: In a partnership firm, there has to be a minimum of two members to start the business. If there is only one member, it is a sole trader business. It also means that the maximum number of partners can be 20 in case of any type of business except banking business in whose case, the maximum number of partners shall be 10. Also, a firm is not allowed to become the partner of another partnership firm. If the number exceeds the prescribes limit, it shall be the case of a illegal business.
- Agreement: Partners should start their business by a mutual agreement. This can be written or in oral. However, written agreement in a partnership firm is advised as it helps in avoiding any controversies. It means that if a owner gives the share of the profit to the employee due to his hard work, it shall not be liable to him to do so regularly unless there is a agreement between the two.
- Lawful business: A firm is called the partnership firm only if it is carried out for the legal purposes to add to the productive capacity of India and its national income. Illegal acts such as smuggling, theft, robbery etc. are not considered partnership firms.
- Sharing of profits:Every partner gives his best for the profits of the firm. Thus, every partner must be given the due share of the profits of the firm. Similarly, every partner is liable to bear the losses of the firm. However,. sharing of profits is not a conclusive proof of partnership. A manager may be given some share in the profits of the firm.
- Unlimited liability: Every parter is jointly and severally liable for the losses of the firm. It means that if the partnership firm at the time of winding up is running in losses, the partners from their personal property has to clear all the dues of the creditors of the firm from whom the partnership firm have taken a loan or purchases goods in credit.
- Restriction in transfer of interest: No partner can transfer his shares in the firm to a third person without the consent of the other partners.
Partnership deed and the formation of a partnership firm The partnership act prescribes the methods for the formation of a partnership firm. The relation between the partners must be to carry on a lawful business for the mutual benefits of all the partners. First of all, the partners have to enter into a contract (oral or in writing). A partnership deed is a document containing the terms and the conditions of the partnership firm. A partnership deed must be signed by all the partners as a token of consent to the terms and the conditions of the partnership firm.
The contents of the partnership firm are as under:
- Name of the firm.
- Name of all the partners and their current and permanent addresses.
- Duration of the partnership firm, if it is a joint venture
- The profit sharing ratio. If nothing is mentioned about it, all the partners shall receive equal profits.
- Rate of interest, on capital additions and personal drawings.
- Allocation of the different work of the firm.
- The principle place off business.
- Procedure for maintaining the accounts of the firm including the method of depreciation to be followed and the methods of getting them audited.
- Mode of valuation of the goodwill.
- Amount of salary or commission to be paid to the partners for their work and financial contributions.
- Procedure for retirement of the partners.
- Clauses of the disputes among the partners and the method of settling them.
Procedure for registration of the firm In order to get a firm registered under the partnership act, a form has to be duly filled in and submitted to the registrar of the state where the principle place of the firm is situated. The application should contain the following information:
- The name of the firm
- The principle state of the business.
- Name of other places where the firm carried on its business activities.
- The date when the partners joined the firm.
- Duration of partnership, if any.
- Name in full and permanent addresses of all the partners.
The application is signed and submitted to the registrar of the firm. The registrar verifies all the details and enter the details in the registry.
Consequences of non-registration An unregistered firm have the following limitations:
- It cannot enforce its claims against a third party in a court of law.
- The firm cannot claim adjustment for any sum exceeding Rs.100. Suppose, an unregistered firm owes Rs. 1200 to A and A owes Rs.1000. The firm cannot claim adjustment of Rs.1000 in the court of law.
- The firm cannot file a case against its members.
- Like the firm, the partners cannot claim any case against its partners.
- No partner can file a case against any of its partners regarding any issues concerning the partnership firm.
Rights and obligations of a partner in a partnership firm
- Every partner has the right to take active part and suggest his ideas for the better management of the partnership firm.
- Every partner has the right to suggest his ideas and put forward solutions in front of other partners irrespective of the number of shares held by him.In case of difference in opinion of all the partners, a voting system takes place that decided on the solutions by a simple majority. However, in case of major changes and problems, there has to be a unanimous decision, a simple majority won't do.
- Every partner has the right to inspect and verify the books of accounts of the partnership firm. He can, at any time, withdraw the books from the safe and enter any transaction, provided that the transaction affects the financial position of the firm.
- Every partner has to be given an equal share in the profits of the firm if nothing is mentioned about the profit sharing ration in the partnership deed. If the ration is specified, the same is provided for.
- In a partnership firm, every partner can make additional capital contributions and provide loans to the firm, if needed, apart from his original capital contribution. If this is the case, every partner can can claim interest on that contribution. The rate of interest is generally 6%, unless otherwise mentioned in the partnership deed.
- No partner can expel the other partner unless desired by the other partner or the second partner had committed a grave error of fraudulent activity.
- If a parter wants to withdraw his support and retire with valid reasons, he is free to do so provided the other partners gives their consent to it.
- Any partner can demand an answer from the other partners of their decisions has severely affected the firm's profits and the decisions has been taken without taking him into confidence.
Duties and liabilities of a partner
- Each of the partner must be honest and regular in his work. He must be active in the management of the business and must be punctual. He must complete his work on time and should be hard working.
- No partner must cross his limits and the power entrusted to him.
- The partners must also consider themselves equally responsible for the losses sustained by the firm and provide for this loss.
- No partner must transfer his share to a third party without the mutual consent of the other partners.
- The partner responsible for the accounting of the firm must maintain true and honest records of all the transactions entered into by the firm.
- If a partner is honest, it also implies that he should, in no way, help the other firms and specially the rival firms in the competition against the own firm by revealing any secrets and future plans of the firm. If he does so, he has to distribute the profits made by him in any such activity to other partners and has to resign from his post.
- The partners must use the current as well as the fixed assets of the firm only for the firm's purposes and not for his personal gains.
- It is one of the duties of the partners to provide for the debts of the firm from their personal property if the assets of the firm are found to be insufficient for clearing the debts of the firm. It means that there should be no case of bad debts sustained by the other people and the creditors of the firm.
Merits and advantages of a partnership firm
- Ease of formation: Partnership firm, unlike the joint stock company, can be easily formed, Two or more relatives have to get together and start the business. Even the registration of the firm is not compulsory. There are very few formalities to be filled by the partners. The agreement can also be in oral. Thus, the partnership firm gets the advantage of an early start and does not loses the momentum.Similarly, it can be winded up easily. The partners just have to clear all the debts of the firm.
- Direct motivation: Since all the partners are equally and severally liable for the debts of the firm, the parters shall try their level best to increase the profits of the firm and avoid any losses. Hence, there is a direct relationship between effort and reward. More is the profits of the firm, more is their share in it.
- Flexibility of operations: Since, the partners does not have to take permissions from the government or provide answer for their activities, the decisions can be taken easily. More than that, the decisions can be implemented easily and quickly.
- Secrecy: No doubt, the partners have to maintain true and correct accounts, bu they do not have to reveal it to the public. Auditing of the firm is not compulsory and no documents have to submitted to the government. Only, the partners have to show their profits for income tax purposes.
- Large financial resources: It is possible for the partners to gather their capital of the firm from other sources as well. It depends on the credit worthiness and trust of the public on the firm. They can invite other partners to contribute their capital.
Demerits and disadvantages of a partnership firm
- Unlimited liability: All the partners have to clear the debts of the firms if the assets of the firm are found to be insufficient. This feature does act as a disincentive for the people to enter into partnership form of business, specially the cautious people and investors. Also, the partners may not think of implementing the new innovative ideas due to the fear of loss.
- Uncertainty: A partnership firm is dissolved as soon as any of the partners becomes insolvent, dies or becomes a lunatic. Any partner can give a notice to the other partners for the dissolution of the firm without any valid reasons.
- Conflicts: Lack of confidence, lack of unity and the difference in the opinion of the partners can result in the quarrel and conflicts among the partners. Chances of conflicts are very high as all the partners have an equal say in the operation of the firm's business.
- Restriction on transfer of interest: A partner cannot transfer his shares to a third party without the mutual consent of the other partners. This makes people to refrain from partnership business.
- Limited resources: As stated earlier, the maximum number of partners allowed is 20. Hence, the capital of a partnership is quites limited and insufficient to take the gains of the economies of scale due to large scale operations and productions. There is a lack of professional management.
- No public confidence: Since the accounts of the partnership firm are not disclosed, to the public, there is a doubt in people's mind regarding the mode of operation of the firm. They may not be interested in investing in the firm. Also, the partnership firm is free form the government restrictions and control. Hence, there is always a fear of bogus company and other fraudulent activities.
Dissolution of a partnership firm A partnership fir is said to be dissolves in case, its activities or normal course of business are stopped and the partners start winding up by selling all the assets of the firm. Dissolution of a partnership firm may take place under various situations.
Dissolution by agreement If the partners agrees unanimously for the dissolution of the firm, they are free to do so provided they have clear all the debts of the firm. Even if one partner protests, dissolution cannot take place.
Dissolution by notice In case of partnership at will, the partners may dissolve the firm at any time by giving a notice to other partners and seeking their permission. In case of such a dissolution, the firm stops its activities from the date of notice given by the partner.
- On the expiry of the term of the partnership firm.
- On the completion of the purpose for which the firm has been formed by the partners.
- A firm may also be dissolved in case of death or lunacy of any of the [partners.
- If any of the partners are proved to be insolvent or bankrupt, the firm is dissolved.
Compulsory dissolutionCompulsory dissolution takes place when the partner have no choice but to wind up. They have to dissolve the firm even against their will. It takes place under the following situations;
- If all the partners are declared bankrupt.
- When the partners are found to be indulged in some illegal activities even if the firm's business is lawful.
Dissolution through court Court may order the dissolution of the partnership firm under the following situations:
- When any of the partner becomes a lunatic.
- When any of the partners becomes physically unsound or challenged or handicapped.
- When the partner is found to be involved in activities such as misappropriation of the goods or misuse of money.
- When any of the partner commits breach of the partnership deed and the other partners prove it to be an intentional act.
- When any of the partner transfer his interest to the third party without the consent of the other partners.
- When the firm is repeatedly suffering a loss due to the malicious acts of personal gains or pocket filling.
Essentials or requisites of an ideal partnership
- Mutual trust and good faith: Every partner must not try all the time to exercise his own discretion. Sometimes, he should place his trust on his partners and try to act as per their will or at least give them a chance to prove themselves. One should avoid conflicts and quarrels. Each partner must give the other partners access to the books of accounts. Ideal partners are never secretive. They must be sincere and dedicated to their duties.
- Common approach: Just as the provision of collective responsibility in our Constitution, the partners must be unanimous in their decisions and suggestions. Not all should try to give their ideas or worse that that, try to get it implemented by force. All the partners must be a good listener and not just good speakers. They must analyze the pros and cones of every aspect of the solutions. There should be a spirit of co-operation. Like, a highly cautious person cannot go with a highly risk bearing person or a speculative person.
- Written agreement: Though the law does not require a written agreement to form a partnership firm, but still there must be one to avoid any conflicts in the future. The partnership deed must be precise and detailed.
- Registration: Though the registration of a partnership firm is not compulsory, but non-registration of a partnership firm snatches away its various rights. Hence, to enjoy various advantages, a partnership firm must be registered.
- Proper size: Though the maximum number of partners as prescribed by the law is 20, but still the huge number of partners just to raise large financial resources result in improper management. There can be utter chaos and confusion. Two to five partners are enough to carry on the business smoothly.
- Supplementary contributions: There must be a proper division between the partners regarding the field they are going to handle. A work should be assigned to a person as per his skills, talents and abilities. There must be proper pooling of resources.
- Long duration: Any medium scale business required a fairly long time to be successful. There must be an adequate time period for which the firm is established.
- Adequate capital: The capital must be adequate without bring over-capitalized. The capital must increase due to the increasing profits and not due to additional capital contribution by the partners as it increases the risk of capital erosion. As far as possible, long term loans an funds must be contributed by the partners.
Types of partners
- Active partner: Such a partner is a real partner is practical terms. An active partner contributes capital and take active part in the management of the business. He has an equal right in the sharing of the profits of the firm.
- Sleeping partner: A sleeping partner does not take part in the management and day to day business of the firm. He just contributes capital and has the right to receive profits of the firm. Such a partner is taken as he is generally a man who can give large resources to the firm.
- Secret partner: The association of such a partner with the firm is not revealed to the outsiders due to certain legal issues. He shares profits and losses of the firm and has unlimited liability. He take active part in the management of the business.
- Limited partner: The liability of such a partner is limited to the capital contribution that he has entitled to contribute. He cannot take part in management of the firm but shares the profits and losses of the firm. The firm cannot be dissolved in the case of death, lunacy or insolvency of the partner.
- Partner by estoppel: A person who by his words or conduct represent himself as a partner of the firm, he becomes liable to all those who have advanced money to the firm. It means that though he does not share the profits of the firm and have not contributed any capital, but remains as a partner. Suppose, a rich man, Mohan is not the partner of the Shipra Enterprises but he tells Sohan that he is a partner of the firm. On the basis of such a guarantee by Mohan, Sohan sells goods to the Shipra. But the firm is not able to pay the money back. In such a case, Mohan has to clear the debts of the firm from his personal property.
- Partner by holding out: When a person is declared a partner of a firm and that person does not deny this fact even after becoming aware of it, he becomes liable to the debts of the firm on the basis of such a declaration.
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