How to Dissolve a Partnership Firm?

A partnership firm is formed when two or more individuals agree to share profits and losses according to a predefined ratio. However, there are occasions when partners may choose to dissolve the firm, effectively closing the business.

Let’s understand what are the circumstances under which a partnership firm is dissolved and how to settle the accounts.

What is a Partnership firm?

A partnership firm is a business structure where two or more individuals share profits and losses according to a predefined ratio. Each partner contributes capital, resources, assets, labor, and other essentials needed to operate the business. The Indian Partnership Act of 1932 governs the formation, operation, and dissolution of a partnership firm. According to Section 39 of this Act, dissolution of a partnership firm leads to the cease of the organization’s existence. It’s important to distinguish between dissolving a partnership firm and dissolving a partnership, as these terms refer to different processes. Let’s clarify these concepts.

Difference Between Dissolution Partnership and Dissolution of Firm

Following is a table that will make it easier for you to understand the difference between dissolution of partnership and dissolution of firm:

Procedure for Dissolution Of Partnership Firm

Once the firm is dissolved, it stands restricted from any transactions afterwards. As per section 39 of the Indian Partnership Act 1932 states that the complete dissolution among all the partners leads to dissolution of the partnership firm. Following is the procedure for dissolution of partnership firm.

1. Dissolution by agreement

• Mutual consent: When all the partners mutually decide to dissolve the firm. This is considered to be the most smooth and convenient process of dissolution.
• Existing contract: If a dissolution contract pre-exists between the parties, the firm shall dissolve accordingly. This may include previously agreed-upon conditions and dissolution procedure.

2. Compulsory dissolution

• Insolvency of partners: If all the partners or all partners except for one becomes insolvent, the firm shall dissolve. They are no longer capable of entering into any contract.
• Illegality of business: Once the firm activities become illegal, dissolution is compulsory.
• Unlawful activities: When occurrence of some events that makes the firm unlawful, the firm shall dissolve. Events such as if a partner is from another country and India starts a war with that country, they are considered enemies and no business can continue.

3. Dissolution due to specific contingencies

• Fixed term or particular venture: The firm shall dissolve if it is framed for a specific period of time or for a particular project. On the expiry date, the firm shall dissolve.
• Death or insolvency: If a partner dies or becomes insolvent, it leads to dissolution of the firm.

4. Dissolution by notice: When the partnership is formed at will, it gives flexibility to any partner to send a notice to the other partners indicating that he intends to dissolve the firm.
5. Dissolution at court: Court has the right to order dissolution of a firm on the following grounds

• Mental or physical incapability
• Misconduct
• Breach of Partnership agreement
• Transfer of interest
• Unsustainable operations
• And all other grounds the court deems equitable.

Winding Up Of Partnership Business: Essentials

By now you know how to dissolve partnership firms. When a firm dissolves, there are some primary activities a firm needs to do. Following are the points that indicate those activities.

• Liquidating all the firm assets.
• Paying off all liabilities
• Finalizing the accounts
• Distribution of funds amongst partners in profit-sharing ratio

Post Dissolution Liabilities: Partners to Third Parties

As long as a public notice of the firm being dissolved is not issued, the partners remain accountable for any actions undertaken by them before the dissolution.

However, there are exceptions to this rule. A partner who becomes insolvent or retires from the firm is not held accountable for any actions taken after their insolvency or retirement. Likewise, the legal heirs of a deceased partner are not liable for any actions undertaken by the remaining partners following the partner’s death..

Premature Dissolution Premium Return

In case a partner has paid a premium to be a part of the partnership being established for a fixed time period and dissolves before that time period, the firm is liable to pay the premium amount back. The refund is subject to the below mentioned conditions.

• Firm is not dissolved due to the death of partner in partnership firm.
• The dissolution is not a result of misconduct of any partner that paid a premium.
• There should not be a specific clause pertaining to non-refundable premium while dissolution of the firm
• The refund of the premium depends on the circumstances surrounding the dissolution of the partnership before the end of its fixed term

Dissolving Firm Account Settlement Procedure

To ensure that all the financial obligations are met, there is a specific order a dissolving firm should follow.

Addressing losses: Firstly all the losses needs to be covered through profits,

• If the profits are insufficient, capital contribution becomes the next source.
• If losses still exist, they are divided among partners as per their profit-sharing ratio.

Assets and capital: The assets and capital by partners will be utilized in the below manner.

• Clearance of outstanding debts to third parties
• Any loan taken by the partners shall be repaid
• Reimbursement for the capital contribution
• Remaining balance to be distributed in profit-sharing ratio

Realization and disposal of assets: All assets will be sold in the market, and the proceeds from these sales will be used to pay off the liabilities. Alternatively, assets or liabilities may be assumed by the partners, and the amounts involved will be reflected in adjustments to the respective partner capital accounts

Dissolution of a partnership firm includes various requirements and procedures on the basis of your circumstances. A firm can be dissolved once financial obligations are met and all assets are distributed and liabilities are paid off. For a smooth dissolution, understanding these steps and requirements is crucial.