Dissolution of a Firm

When the partnership between all the partners of a firm is dissolved, then it is called dissolution of a firm. It is important to note that the relationship between all partners should be dissolved for the firm to be dissolved. Let us look at the legal provisions for the dissolution of a firm.

Modes of Dissolution of a Firm

A firm can be dissolved either voluntarily or by an order from the Court.

Voluntary Dissolution of a Firm (without the order of the Court)

Voluntary dissolution can be of four types. Let us take a look.

 

Learn more about Dissolution of Partnership Firm here in detail.

 

1] By Agreement (Section 40)

According to Section 40 of the Indian Partnership Act, 1932, partners can dissolve the partnership by agreement and with the consent of all partners. Partners can also dissolve the partnership based on a contract that has already been made.

Browse more Topics under The Indian Partnership Act

• True Test of Partnership
• Elements of a Partnership
• Kinds of Partnerships
• Types of Partners
• Relation of Partners to One Another
• Relation of Partners to Third Parties
• Partnership Property
• Minors admitted to Benefits of partnership
• Rights of Outgoing Partner
• Legal Consequences of Admission or Retirement of a Partner
• Consequences of Non-Registration of Firm
• Consequences of Dissolution of a Firm

2] Compulsory Dissolution (Section 41)

An event can make it unlawful for the firm to carry on its business. In such cases, it is compulsory for the firm to dissolve. However, if a firm carries on more than one undertakings and one of them becomes illegal, then it is not compulsory for the firm to dissolve. It can continue carrying out the legal undertakings. Section 41 of the Indian Partnership Act, 1932, specifies this type of voluntary dissolution.

3] On the happening of certain contingencies (Section 42)

According to Section 42 of the Indian Partnership Act, 1932, the happening of any of the following contingencies can lead to the dissolution of the firm:

• Some firms are constituted for a fixed term. Such firms will dissolve on the expiry of that term.
• Some firms are constituted to carry out one or more undertaking. Such firms are dissolved when the undertaking is completed.
• Death of a partner.
• Insolvent partner.

4] By notice of partnership at will (Section 43)

According to Section 43 of the Indian Partnership Act, 1932, if the partnership is at will, then any partner can give notice in writing to all other partners informing them about his intention to dissolve the firm.

In such cases, the firm is dissolved on the date mentioned in the notice. If no date is mentioned, then the date of dissolution of the firm is the date of communication of the notice.

Dissolution of a Firm by the Court

According to Section 44 of the Indian Partnership Act, 1932, the Court may dissolve a firm on the suit of a partner on any of the following grounds:

1] Insanity/Unsound mind

If an active partner becomes insane or of an unsound mind, and other partners or the next friend files a suit in the court, then the court may dissolve the firm. Two things to remember here:

• The partner is not a sleeping partner
• The sickness is not temporary

2] Permanent Incapacity

If a partner becomes permanently incapable of performing his duties as a partner, and other partners file a suit in the court, then the court may dissolve the firm. Also, the incapacity may arise from a physical disability, illness, etc.

3] Misconduct

When a partner is guilty of conduct which is likely to affect prejudicially the carrying on of the business, and the other partners file a suit in the court, then the court may dissolve the firm.

Further, it is not important that the misconduct is related to the conduct of the business. The court looks at the effect of the misconduct on the business along with the nature of the business.

4] Persistent Breach of the Agreement

A partner may willfully or persistently commit a breach of the agreement relating to

• the management of the affairs of the firm, or
• a reasonable conduct of its business, or
• conduct himself in matters relating to business that is not reasonably practicable for other partners to carry on the business in partnership with him.

In such cases, the other partners may file a suit against him in the court and the court may order to dissolve the firm. The following acts fall in the category of breach of agreement:

1. Embezzlement
2. Keeping erroneous accounts
3. Holding more cash than allowed
4. Refusal to show accounts despite repeated requests, etc.

5] Transfer of Interest

A partner may transfer all his interest in the firm to a third party or allow the court to charge or sell his share in the recovery of arrears of land revenue. Now, if the other partners file a suit against him in the court, then the court may dissolve the firm.

6] Continuous/Perpetual losses

If a firm is running under losses and the court believes that the business of the firm cannot be carried on without a loss in the future too, then it may dissolve the firm.

7] Just and equitable grounds

The court may find other just and equitable grounds for the dissolution of the firm. Some such grounds are:

• Deadlock in management
• Partners not being in talking terms with each other
• Loss of substratum (the foundation of the business)
• Gambling by a partner on the stock exchange.

Difference between Dissolution of a firm and Dissolution of a Partnership

Parameters	Dissolution of a Firm	Dissolution of a Partnership
Continuation of business	The business discontinues.	The business continues. However, the partnership is reconstituted.
Winding up	The firm is wound up. Assets are realized and liabilities are settled.	Assets and liabilities of the firm are only revalued.
Court order	A Court Order can dissolve a firm.	A Court Order cannot dissolve a partnership.
Scope	It involves the dissolution of partnership between all partners.	It does not involve the dissolution of the firm.
Final closure of books	Yes	No

Solved Examples on Dissolution of a Firm

Q: Peter Chemicals is a firm in the business of trading a particular chemical. A new law bans the trading of that particular chemical. What happens to Peter Chemicals?

Answer: The business of the firm becomes unlawful after the passing of the law banning trading in the said chemical. Therefore, it is compulsory for Peter Chemicals to dissolve.

Q: Peter, John, and Oliver are partners in PJO & Co. – a partnership firm. Peter and John know that Oliver has been keeping erroneous accounts for many months. He has also not heeded to their requests of entering receipts in time. Can they file a case against Oliver? Also, what stand can the court take?

Answer: Oliver’s behavior clearly destroys the mutual confidence between the partners. If Peter and John file a case against Oliver, then the court may order a dissolution of the firm.