The Partnership Act, 1932 & the LLP Act, 2008 — Practice

Question 1

State the definition of partnership and explain the true test for determining its existence. Why is sharing of profits not conclusive?

Accepted Answer

Definition. Section 4 of the Indian Partnership Act, 1932 defines partnership as the relation between persons who have agreed to share the profits of a business carried on by all or any of them acting for all. Persons who have entered into partnership with one another are individually called partners and collectively a firm, and the name under which their business is carried on is the firm name.

The essentials are an association of two or more persons, an agreement between them, a business, an agreement to share profits, and the business being carried on by all or any of them acting for all.

The true test. Section 6 provides that in determining whether a group of persons is or is not a firm, regard shall be had to the real relation between the parties as shown by all relevant facts taken together.

The true test is mutual agency. Each partner must be both an agent of the firm and of the other partners, and a principal bound by their acts within the ordinary course of the business. A person who cannot bind the others, and cannot be bound by them, is not a partner however he is remunerated.

Why profit sharing is not conclusive. The explanation to section 6 states expressly that the receipt by a person of a share of the profits of a business does not of itself make him a partner. Profit sharing is strong evidence, but it is one fact among all the relevant facts.

The explanation lists cases where a person receives profits without being a partner: a lender of money to a person engaged in business, receiving interest varying with the profits or a share of the profits; a servant or agent of the business remunerated by a share of the profits; the widow or child of a deceased partner receiving an annuity out of profits; and a previous owner or part owner of the business receiving a portion of the profits as consideration for the sale of the goodwill.

In none of these is there mutual agency. The lender cannot bind the business, the employee acts under direction rather than as a principal, the widow has no role in the business at all, and the seller of goodwill has parted with the business entirely. Each is paid out of profits for a reason unconnected with being a co-owner of the venture.

The practical instruction for a problem is therefore to identify who can bind whom, not who receives what.

Question 2

Advise whether a partnership exists in each case: (a) A lends ₹20,00,000 to B's business and is to receive 15% of the annual profits as interest, with no say in management; (b) C manages a shop for D on a salary of ₹40,000 a month plus 10% of profits, and cannot bind D without approval; (c) E and F jointly purchase a plot of land as an investment and share the rent; (d) G and H buy goods together intending to resell them at a profit, each authorised to sell on behalf of both.

Accepted Answer

Provision. Under section 4 partnership is the relation between persons who have agreed to share the profits of a business carried on by all or any of them acting for all. Section 6 requires regard to the real relation between the parties from all relevant facts, and its explanation makes clear that receipt of a share of profits does not of itself make a person a partner. The true test is mutual agency.

(a) The lender receiving 15% of profits as interest. No partnership. A lender of money to a person engaged in business who receives interest varying with the profits, or a share of the profits, is expressly identified in the explanation to section 6 as not thereby a partner. A has no say in management, cannot bind the business and is not bound by it. He is a creditor whose return happens to be measured by profits, which is a method of pricing the loan rather than a share in the venture.

(b) The manager on salary plus 10% of profits. No partnership. A servant or agent of a person engaged in business, receiving remuneration by a share of the profits, is another of the express cases. The decisive fact is stated in the question: C cannot bind D without approval. He acts under direction rather than as a principal, so there is no mutual agency. The profit share is an incentive component of remuneration.

(c) E and F jointly purchasing land and sharing rent. No partnership. This is co-ownership. There is no business being carried on — merely joint ownership of an asset producing income — and no mutual agency between them. Co-ownership may arise without agreement, does not necessarily involve profit-sharing from a business, and permits each co-owner to transfer his interest without the other's consent, none of which is true of partnership. Either may claim partition, which a partner cannot.

(d) G and H buying goods together to resell, each authorised to sell for both. Partnership exists. All the essentials are present: two persons, an agreement, a business in the form of a venture to buy and resell for profit, an agreement to share the profits, and critically the mutual agency shown by each being authorised to sell on behalf of both.

The fact that this is a single venture does not prevent it being a partnership. A single adventure or undertaking may constitute a business, and such an arrangement is a particular partnership which comes to an end when the venture is complete.

The contrast between (c) and (d) is instructive: the same two people owning property together are co-owners, but the moment they carry on a business with authority to act for each other they become partners.

Question 3

State the scope of a partner's implied authority and the acts it does not extend to. Advise whether the firm is bound where a partner in a trading firm, without the others' consent, (a) buys goods on credit for the firm; (b) refers a dispute with a supplier to arbitration; (c) sells a warehouse owned by the firm; (d) engages an employee.

Accepted Answer

Provision. Section 19 provides that, subject to the provisions of section 22, the act of a partner which is done to carry on, in the usual way, business of the kind carried on by the firm, binds the firm. The authority of a partner to bind the firm conferred by this section is called his implied authority.

The section then provides that in the absence of any usage or custom of trade to the contrary, the implied authority of a partner does not empower him to submit a dispute relating to the business of the firm to arbitration; open a banking account on behalf of the firm in his own name; compromise or relinquish any claim or portion of a claim by the firm; withdraw a suit or proceeding filed on behalf of the firm; admit any liability in a suit or proceeding against the firm; acquire immovable property on behalf of the firm; transfer immovable property belonging to the firm; or enter into partnership on behalf of the firm.

The unifying idea is that each of these acts either disposes of the firm's rights or alters its structure, and none is carrying on the business in the usual way.

(a) Buying goods on credit for the firm. The firm is bound. Purchasing goods on credit is an ordinary act in carrying on the business of a trading firm in the usual way, and it falls squarely within implied authority. The other partners' consent is not required, and a supplier dealing in good faith may hold the firm.

(b) Referring a dispute to arbitration. The firm is not bound. Submitting a dispute relating to the business to arbitration is the first of the excluded acts. It requires the express authority of the other partners, because it substitutes a different forum and a different procedure for the firm's ordinary legal rights. The position would differ only if a usage or custom of the trade authorised it.

(c) Selling a warehouse owned by the firm. The firm is not bound. Transfer of immovable property belonging to the firm is expressly excluded from implied authority. The reason is that immovable property is not the stock in trade of a trading firm, and disposing of it is not carrying on the business in the usual way but disposing of the means by which it is carried on. Express authority is required.

(d) Engaging an employee. The firm is bound. Hiring staff to carry on the business is an ordinary incident of running a trading firm and is not among the excluded acts. It falls within implied authority.

A final point. Section 20 permits the partners to restrict a partner's implied authority by contract between themselves, but such a restriction does not affect a third party dealing with the firm unless that third party knows of it. So even in cases (a) and (d), an internal agreement requiring consent would not protect the firm against an unaware supplier or employee.

Question 4

Registration of a firm is optional under the Indian Partnership Act, 1932. Explain the consequences of non-registration and the exceptions, and advise whether an unregistered firm may (a) sue a customer for the price of goods supplied; (b) be sued by that customer for defective goods; (c) sue for dissolution.

Accepted Answer

Provision. Registration of a firm is not compulsory and no penalty attaches to non-registration. But section 69 imposes disabilities that make registration practically necessary.

The consequences of non-registration are three. No suit to enforce a right arising from a contract or conferred by the Act may be instituted by a partner against the firm or any person alleged to be or to have been a partner in the firm, unless the firm is registered and the person suing is or has been shown in the register of firms as a partner. No suit to enforce a right arising from a contract may be instituted by or on behalf of a firm against any third party unless the firm is registered and the persons suing are or have been shown in the register as partners. And the same disability applies to a claim of set-off exceeding one hundred rupees, or other proceedings to enforce a right arising from a contract.

The exceptions, where non-registration does not bar the claim: the right to sue for the dissolution of a firm; the right to sue for accounts of a dissolved firm; the right to realise the property of a dissolved firm; the powers of an official assignee, receiver or court under insolvency law to realise the property of an insolvent partner; suits or claims not exceeding one hundred rupees in value; suits by third parties against the firm; rights arising otherwise than out of contract, such as a suit for infringement of a trade mark or for a tort; and firms in areas exempted from the registration provisions.

(a) Suing a customer for the price of goods supplied. Not permitted. This is a suit by the firm against a third party to enforce a right arising from a contract, which is precisely what section 69 bars. The firm must register, and the partners must be shown in the register, before instituting the suit. Registering after the suit has been filed does not cure the defect — the requirement is tested at the date of institution — so the suit would have to be withdrawn and refiled after registration, by which time limitation may have expired.

(b) Being sued by the customer for defective goods. Permitted. Section 69 disables the firm from suing; it does not protect the firm from being sued. A third party may sue an unregistered firm exactly as he could a registered one.

The asymmetry is the point of the provision and should be stated expressly. Registration exists so that persons dealing with a firm can ascertain who its partners are, and the sanction for not registering is a disability imposed on the firm, not a shield given to it. It would be perverse if failing to register conferred immunity from suit.

(c) Suing for dissolution. Permitted. The right to sue for the dissolution of a firm is an express exception to section 69, as are suits for accounts of a dissolved firm and for realisation of its property.

The reason is that without these exceptions, partners in an unregistered firm would be unable to bring it to an end or to have their accounts settled, and would be trapped indefinitely in a relationship they wished to terminate. The Act penalises the firm's dealings with the outside world, not the partners' ability to extricate themselves.

Question 5

Distinguish a sleeping partner from a nominal partner, and explain why a sleeping partner need not give public notice on retirement while an active partner must.

Accepted Answer

Sleeping or dormant partner. A person who contributes capital to the firm and shares in its profits and losses, but who does not take any part in the conduct of the business. His membership is generally not known to those dealing with the firm.

Nominal partner. A person who lends his name to the firm without contributing any capital and without sharing in its profits. He takes no part in the business and has no real interest in it, but he permits himself to be represented as a partner.

The distinctions.

Capital: a sleeping partner contributes capital; a nominal partner contributes none.

Share of profits: a sleeping partner shares profits and losses; a nominal partner does not.

Interest in the business: a sleeping partner has a real proprietary interest; a nominal partner has none.

Knowledge of third parties: a sleeping partner's membership is usually unknown to outsiders; a nominal partner's supposed membership is precisely what is known and relied on.

Liability: both are liable to third parties for the acts of the firm. A sleeping partner is liable because he is in truth a partner; a nominal partner is liable on the principle of holding out, to anyone who gave credit to the firm on the faith of the representation.

Why public notice differs.

A retiring partner continues to be liable to third parties for acts of the firm done after his retirement until public notice of the retirement is given. Section 32 makes an express exception for a sleeping partner, and the same exemption applies to the estate of a deceased partner and to a partner adjudicated insolvent.

The reason follows from the purpose of public notice. Its function is to correct a belief on which third parties may be relying — the belief that a particular person stands behind the firm's obligations. An active partner's membership is known to those dealing with the firm, and they may continue to extend credit on the strength of it, so his retirement must be publicised to end that reliance.

A sleeping partner's membership was never known to third parties. Nobody gave credit on the faith of it, so nobody's expectation needs to be corrected. Requiring notice of the retirement of a person whose participation was never apparent would serve no purpose, since the notice would tell the public something they never knew in the first place.

Question 6

State the position of a minor in a partnership firm under section 30, including his rights, liabilities and the election he must make on attaining majority. Advise a minor admitted to the benefits who takes no action for eight months after turning eighteen.

Accepted Answer

Provision. A minor cannot be a partner, because partnership arises from contract and a minor's agreement is void ab initio. Section 30 provides that a minor may, with the consent of all the partners for the time being, be admitted to the benefits of partnership.

Rights during minority. He is entitled to such share of the property and profits of the firm as may be agreed upon. He has a right of access to, and may inspect and copy, any of the accounts of the firm — note that this is confined to the accounts, and does not extend to the other books, the restriction existing because those may contain trade secrets he could exploit on leaving.

Liabilities during minority. His share is liable for the acts of the firm, but he is not personally liable for any such act. A creditor may therefore reach the minor's share in the firm but cannot proceed against his private estate.

Suit during minority. He cannot sue the partners for an account or payment of his share of the property or profits of the firm, except when severing his connection with the firm, in which case the amount of his share is determined by valuation.

Election on attaining majority. At any time within six months of attaining majority, or of obtaining knowledge that he had been admitted to the benefits of partnership, whichever date is later, the minor may give public notice that he has elected to become, or that he has elected not to become, a partner in the firm. Such notice determines his position as regards the firm.

The critical provision. If he fails to give such notice, he becomes a partner in the firm on the expiry of the said six months.

Consequences of becoming a partner. His rights and liabilities as a minor continue up to the date on which he becomes a partner, but he becomes personally liable to third parties for all acts of the firm done since he was admitted to the benefits of partnership — his liability is retrospective to the date of admission, not merely from the date of majority. His share in the property and profits remains the share to which he was entitled as a minor.

Consequences of electing not to become a partner. His rights and liabilities continue to be those of a minor up to the date of the notice. His share is not liable for any acts of the firm done after the date of the notice, and he is entitled to sue the partners for his share of the property and profits.

Application. The minor has taken no action for eight months after attaining majority. The six-month period has expired without any public notice being given.

He has therefore become a partner in the firm by operation of law. He is now personally liable to third parties for all acts of the firm done since the date he was originally admitted to the benefits of partnership — a liability extending back well before his eighteenth birthday and reaching his private assets, not merely his share.

This is the trap in most problems on section 30. Inaction is not neutral: silence for six months converts a protected position into full personal liability with retrospective effect.

Question 7

Distinguish a Limited Liability Partnership from a general partnership on at least six named bases, and explain the liability of an LLP partner.

Accepted Answer

Legal status. An LLP is a body corporate formed and incorporated under the Limited Liability Partnership Act, 2008, and is a legal entity separate from its partners. A partnership firm is not a legal entity distinct from its partners; the firm name is merely a compendious way of referring to them.

Liability of partners. In an LLP, a partner is not personally liable for the obligations of the LLP solely by reason of being a partner. In a general partnership, every partner is jointly and severally liable, to an unlimited extent, for all acts of the firm done while he is a partner.

Perpetual succession. An LLP has perpetual succession, and any change in its partners does not affect its existence, rights or liabilities. A partnership firm has no perpetual succession, and is affected by the death, retirement or insolvency of a partner.

Number of partners. An LLP requires a minimum of two partners and has no maximum. A partnership requires two and is subject to the maximum number prescribed under the Companies Act.

Registration. Incorporation of an LLP is compulsory — the entity does not come into existence until incorporated. Registration of a partnership firm is optional, though section 69 of the Partnership Act imposes serious disabilities on an unregistered firm.

Governing law and regulator. The LLP Act, 2008, administered by the Registrar of Companies under the Ministry of Corporate Affairs. The Indian Partnership Act, 1932, administered by the Registrar of Firms.

Property. An LLP can own, hold and dispose of property in its own name. The property of a firm is held by the partners.

Agency. A partner in an LLP is an agent of the LLP alone, and not of the other partners. In a firm, every partner is an agent of the firm and of the other partners, which is the mutual agency that defines partnership.

Capacity to sue. An LLP can sue and be sued in its own name. A firm sues and is sued through its partners.

Liability of an LLP partner.

The LLP is liable for the wrongful act or omission of a partner acting in the course of its business or with its authority, and the liabilities of the LLP are met out of its property. An obligation of the LLP, whether arising in contract or otherwise, is solely the obligation of the LLP.

A partner is not personally liable, directly or indirectly, for such an obligation solely by reason of being a partner.

But the protection is not absolute, and stating the limits is what earns the marks. A partner remains personally liable for his own wrongful act or omission — the LLP's separate personality does not shield a person from the consequences of his own conduct. And where the LLP or any of its partners carries on business with intent to defraud creditors of the LLP or any other person, or for any fraudulent purpose, the liability of the LLP and of the partners who acted with that intent is unlimited.

Question 8

Distinguish partnership from a Hindu Undivided Family business and from co-ownership.

Accepted Answer

Partnership and a Hindu Undivided Family business.

Mode of creation. A partnership is created by agreement between the parties. A HUF business arises by operation of law from status; a person becomes a coparcener by birth into the family.

Acquisition of interest. A partner acquires his interest only by agreement. A coparcener acquires an interest in the family business by birth, without any agreement.

Authority to bind. Every partner has implied authority to bind the firm by acts done in carrying on the business in the usual way. In a HUF business only the karta has that authority; other coparceners cannot bind the family by their dealings.

Liability. Partners are jointly and severally liable to an unlimited extent, and their personal estates are exposed. In a HUF, the liability of coparceners other than the karta is limited to their share in the family property; the karta alone is personally liable without limit.

Minors. A minor cannot be a partner and may only be admitted to the benefits of partnership with the consent of all partners. A minor is a coparcener in a HUF from birth and needs no one's consent.

Death. The death of a partner ordinarily dissolves the firm in the absence of contrary agreement. The death of a coparcener does not dissolve the HUF business, which continues.

Right to accounts. A partner may demand accounts of the firm. A coparcener has no right to ask for accounts of past dealings; he may only demand an account of the existing property on partition.

Governing law. The Indian Partnership Act, 1932, against Hindu law.

Partnership and co-ownership.

Mode of creation. Partnership arises only from agreement. Co-ownership may arise without agreement, as by inheritance or by the operation of law.

Business. Partnership necessarily involves carrying on a business. Co-ownership does not; two persons may own property jointly without any business at all.

Profit sharing. Partners agree to share profits. Co-owners need not; each simply takes his share of any income by virtue of ownership.

Mutual agency. Partners are agents of one another for the purposes of the business — this is the true test of partnership. There is no mutual agency between co-owners, and one co-owner cannot bind another.

Transfer of interest. A partner cannot transfer his interest so as to make the transferee a partner without the consent of all the other partners. A co-owner may transfer his interest freely without anyone's consent.

Remedy. A co-owner may sue for partition of the property. A partner cannot demand partition of firm property; his remedy is to seek dissolution and settlement of accounts, taking his share in money.

Lien. A partner has a lien on the partnership property for expenses incurred on behalf of the firm. A co-owner has no such lien.

Question 9

State the modes of dissolution of a firm and the order in which accounts are settled under section 48. Advise on the position of partners' liability for acts done after dissolution.

Accepted Answer

Meaning. Dissolution of a firm means the dissolution of the partnership between all the partners of a firm. Where the partnership between some of the partners only comes to an end and the business continues, that is a reconstitution and not a dissolution of the firm.

Modes of dissolution.

By agreement. A firm may be dissolved with the consent of all the partners, or in accordance with a contract between them.

Compulsory dissolution. A firm is compulsorily dissolved by the adjudication of all the partners, or of all but one, as insolvent; or by the happening of any event which makes it unlawful for the business of the firm to be carried on or for the partners to carry it on in partnership. Where the business consists of several undertakings and only one becomes unlawful, the firm is not dissolved as to the lawful ones.

On the happening of certain contingencies, subject to contract between the partners: the expiry of the term where the firm is constituted for a fixed term; the completion of the adventure or undertaking where it is constituted for that purpose; the death of a partner; the adjudication of a partner as insolvent.

By notice. Where the partnership is at will, the firm may be dissolved by any partner giving notice in writing to all the other partners of his intention to dissolve.

By the court, on a suit by a partner, on any of these grounds: a partner has become of unsound mind; a partner has become permanently incapable of performing his duties; a partner is guilty of conduct likely to affect prejudicially the carrying on of the business; a partner wilfully or persistently commits breach of the agreement or otherwise conducts himself so that it is not reasonably practicable for the others to carry on business with him; a partner has transferred the whole of his interest to a third party; the business cannot be carried on save at a loss; or on any other ground which renders it just and equitable that the firm should be dissolved.

Settlement of accounts under section 48.

Losses, including deficiencies of capital, are paid first out of profits, next out of capital, and lastly, if necessary, by the partners individually in the proportions in which they were entitled to share profits.

The assets of the firm, including any sums contributed by partners to make up deficiencies of capital, are applied in the following order:

First, in paying the debts of the firm to third parties.
Secondly, in paying to each partner rateably what is due to him from the firm for advances, as distinguished from capital.
Thirdly, in paying to each partner rateably what is due to him on account of capital.
And the residue, if any, is divided among the partners in the proportions in which they were entitled to share profits.

The ranking of advances ahead of capital is the point most often missed. A loan by a partner to the firm is a debt owed to him in a different character from his capital contribution, and it is paid before any capital is returned to anyone.

Liability for acts done after dissolution.

Notwithstanding the dissolution, partners continue to be liable as such to third parties for any act done by any of them which would have been an act of the firm if done before the dissolution, until public notice is given of the dissolution.

Three exceptions apply. The estate of a partner who dies, a partner who is adjudicated insolvent, and a sleeping partner who was not known to be a partner to the person dealing with the firm are not liable for acts done after the date on which they ceased to be partners — and no public notice is required in their cases.

The reason is the same as for retirement: public notice exists to correct a reliance that third parties may be placing on a person's membership. Where no such reliance existed, or where the cessation is a matter of public record as with death or insolvency, there is nothing to correct.

Partners also retain authority after dissolution, so far as is necessary to wind up the affairs of the firm and to complete transactions begun but unfinished at the time of dissolution.

Question 10

State the rights and duties of partners, distinguishing those duties that cannot be varied by agreement from those that can. Explain why the Act draws that distinction.

Accepted Answer

Rights of partners, subject to contract between them.

To take part in the conduct of the business of the firm.
To be consulted and heard before any matter is decided, ordinary matters connected with the business being decided by a majority of the partners, and no change in the nature of the business being made without the consent of all.
To have access to, and to inspect and copy, any of the books of the firm.
To share equally in the profits earned, and to contribute equally to losses.
To receive interest on capital only out of profits, where the agreement provides for it.
To receive interest at six per cent per annum on advances made beyond the amount of capital he agreed to subscribe, this being payable as a charge and not merely out of profits.
To be indemnified by the firm in respect of payments made and liabilities incurred in the ordinary and proper conduct of the business, and in doing such act in an emergency for protecting the firm from loss as a person of ordinary prudence would do in his own case.
To act in an emergency for the purpose of protecting the firm from loss.
Not to be expelled from the firm except in good faith by a majority of the partners in exercise of a power conferred by contract.

Duties that cannot be varied by agreement.

To carry on the business of the firm to the greatest common advantage.
To be just and faithful to each other.
To render true accounts and full information of all things affecting the firm to any partner or his legal representative.

Duties that can be varied by agreement.

To indemnify the firm for any loss caused to it by fraud in the conduct of the business — though note that the duty to indemnify for fraud is itself often stated as absolute, since an agreement licensing fraud would be void as opposed to public policy.
To indemnify the firm for loss caused by wilful neglect in the conduct of the business.
To attend diligently to his duties in the conduct of the business.
Not to claim remuneration for taking part in the conduct of the business.
To share losses equally.
To hold and use the property of the firm exclusively for the purposes of the business.
To account to the firm for any profit derived from any transaction of the firm, or from the use of the property, business connection or firm name.
To account for and pay over to the firm all profits made in a competing business carried on without the consent of the other partners.

Why the Act draws the distinction.

The three unvarying duties are all aspects of a single obligation: the fiduciary duty partners owe one another. Partnership is a relationship of utmost good faith. Each partner entrusts his capital, his credit and his personal liability to the judgement of the others, and each has the power to bind them all without prior consultation through his implied authority.

That power is only tolerable if it is accompanied by an unqualified obligation of honesty. A partner who could contract out of the duty to be just and faithful, or out of the duty to render true accounts, would hold the power to bind his co-partners without any corresponding obligation to deal with them honestly — which would make mutual agency intolerable and the relationship unworkable.

The variable duties, by contrast, concern the internal economic arrangements of the firm: who works, who is paid, how profits and losses are shared, whether a partner may pursue other interests. These are matters the partners are best placed to settle for themselves, and there is no reason of policy why they should not. A firm may perfectly properly agree that one partner will be remunerated for managing the business, that another need not attend at all, or that losses will be shared unequally.

The line the Act draws is therefore between the integrity of the relationship, which is not negotiable, and its commercial terms, which are entirely so.

Question 11

A retires from a firm on 1 April. No public notice is given. On 1 June, B, a continuing partner, buys goods on credit for the firm from a supplier who had dealt with the firm for years and did not know of A's retirement. On 1 August the firm is dissolved. Advise the supplier on his remedies against A, and explain how the position would differ if A had been a sleeping partner.

Accepted Answer

Provision. A retiring partner continues to be liable to third parties for any act of the firm done after his retirement until public notice of the retirement is given. Notice may be given by the retiring partner or by any partner of the reconstituted firm.

Section 32 makes an exception: a retired partner who was not known to the person dealing with the firm to be a partner — that is, a sleeping partner — is not liable for acts done after his retirement, and no public notice is required in his case.

Application where A was an active partner.

A retired on 1 April but no public notice was given. The purchase on 1 June is an act of the firm done after his retirement but before any notice.

The supplier had dealt with the firm for years and did not know of the retirement. He extended credit on the faith of the firm as he understood it to be constituted, which included A. That is precisely the reliance public notice exists to end, and it was not ended.

A is therefore liable to the supplier for the price of the goods bought on 1 June, jointly and severally with the other partners. The supplier may proceed against A alone for the whole amount if he chooses, since partners' liability is joint and several.

A's remedy is against the continuing partners. As between the partners themselves, the debt was incurred after his retirement and is properly theirs, so he is entitled to be indemnified by them for what he is compelled to pay. That is a matter between the partners and does not affect the supplier.

The subsequent dissolution on 1 August is irrelevant to this liability, which had already been incurred. Dissolution does not extinguish debts already contracted.

How the position would differ if A had been a sleeping partner.

A sleeping partner takes no part in the conduct of the business and his membership is not known to those dealing with the firm. The facts state that the supplier did not know of A's retirement, but the material question for a sleeping partner is whether the supplier knew of his membership at all.

If A was a sleeping partner whose membership was unknown to the supplier, no public notice was required and A is not liable for the purchase of 1 June.

The reason is that the function of public notice is to correct a belief on which a third party may be relying. The supplier who never knew A was a partner cannot have extended credit on the faith of A's membership, and there is accordingly nothing to correct. Requiring notice would mean publicising a fact the public never knew.

Note that a sleeping partner remains fully liable for acts done while he was a partner. The exemption concerns only acts after his retirement, and only where his membership was genuinely unknown to the person dealing with the firm. If the supplier had in fact known A was a partner, the exemption would not apply and A would be liable exactly as an active partner would be.

The same exemption applies to the estate of a deceased partner and to a partner adjudicated insolvent, for the analogous reason that their cessation is a matter of record.

Question 12

A firm of three partners is unregistered. Partner P wishes to sue partner Q for his share of profits; the firm wishes to recover ₹9,00,000 from a customer; a supplier has sued the firm and the firm wishes to set off ₹4,00,000 the supplier owes it. Advise on each, and on what the firm should do.

Accepted Answer

Provision. Section 69 of the Indian Partnership Act, 1932 imposes three disabilities on an unregistered firm and its partners.

No suit to enforce a right arising from a contract or conferred by the Act may be instituted in any court by or on behalf of any person suing as a partner in a firm against the firm or any person alleged to be or to have been a partner in the firm, unless the firm is registered and the person suing is or has been shown in the register of firms as a partner in the firm.

No suit to enforce a right arising from a contract may be instituted by or on behalf of a firm against any third party unless the firm is registered and the persons suing are or have been shown in the register as partners.

These provisions apply also to a claim of set-off, and to other proceedings to enforce a right arising from a contract, except that a claim of set-off not exceeding one hundred rupees in value is not affected.

P's suit against Q for his share of profits.

Barred. This is a suit by a person suing as a partner against a person alleged to be a partner, to enforce a right arising from the contract of partnership and conferred by the Act. It falls squarely within the first disability.

Note what is not barred. Had P wished to sue for the dissolution of the firm, or for accounts of a dissolved firm, or to realise the property of a dissolved firm, those are express exceptions and would be maintainable notwithstanding non-registration. So P has a route: he may sue for dissolution and, on dissolution, for accounts, in the course of which his share of profits will be determined and paid.

The firm's suit against the customer for ₹9,00,000.

Barred. This is a suit by the firm against a third party to enforce a right arising from a contract, which the second disability prohibits. The firm cannot maintain the suit while unregistered.

The firm's claim of set-off for ₹4,00,000.

Barred. Section 69 extends expressly to a claim of set-off. The exception is confined to claims not exceeding one hundred rupees, and ₹4,00,000 is far beyond that.

The practical consequence is severe. The supplier may prosecute his suit against the firm to judgment, and the firm must pay, while being unable to set off the ₹4,00,000 the supplier owes it. The firm is exposed to the whole of the supplier's claim with no ability to reduce it.

Note also that the supplier's suit against the firm is perfectly maintainable. Section 69 disables the firm from suing; it does not prevent third parties from suing the firm. The disability runs in one direction only.

What the firm should do.

Register immediately by filing a statement with the Registrar of Firms containing the firm name, the place of business, the names and addresses of all partners and the dates on which they joined, signed and verified by all the partners.

Registration must precede the institution of any suit. It is well settled that a defect under section 69 is not cured by registering after the suit has been filed; the requirement is tested at the date of institution, and a suit filed by an unregistered firm must be withdrawn and refiled after registration.

The firm must therefore register before suing the customer for ₹9,00,000, and it should do so urgently, because the period of limitation continues to run while the firm remains unable to sue. A claim can be lost entirely through the delay.

The set-off position is more urgent still, since the supplier's suit is already pending and the firm's ability to plead a set-off depends on registration being effected in time.

The wider lesson, and the reason the provision is examined so often, is that although registration is described as optional, the disabilities make it effectively compulsory for any firm that expects to deal on credit or to enforce its contracts.

Question 13

Explain the concept of the LLP, the role of designated partners, and the circumstances in which an LLP partner's liability becomes unlimited. Distinguish an LLP from a company.

Accepted Answer

The concept. A limited liability partnership is a body corporate formed and incorporated under the Limited Liability Partnership Act, 2008. It is a legal entity separate from its partners and has perpetual succession, so any change in the partners does not affect its existence, rights or liabilities. It can own property in its own name, and can sue and be sued in its own name.

Why it exists. A traditional partnership imposes unlimited joint and several liability on every partner for the acts of every other, which is untenable in a large professional firm where a partner may be ruined by the negligence of someone he has never met. A company solves that but brings heavy compliance, rigid governance and the separation of ownership from management. The LLP combines the limited liability of a company with the operational flexibility of a partnership, and the mutual rights and duties of the partners are governed by the LLP agreement rather than by statute, with the First Schedule applying only where the agreement is silent.

Designated partners. Every LLP must have at least two designated partners who are individuals, and at least one of them must be a resident in India. Each requires a Designated Partner Identification Number.

Their role is compliance. Designated partners are responsible for doing all acts, matters and things required to be done by the LLP under the Act, including the filing of documents, returns and statements. They are liable to all penalties imposed on the LLP for any contravention of those provisions. A body corporate partner may nominate an individual to act as a designated partner.

When liability becomes unlimited.

The general position is that a partner is not personally liable, directly or indirectly, for an obligation of the LLP solely by reason of being a partner, and that an obligation of the LLP, whether in contract or otherwise, is solely the obligation of the LLP, met out of its property.

The protection is displaced in two situations.

First, a partner remains personally liable for his own wrongful act or omission. The LLP's separate personality shields a partner from the consequences of another partner's conduct, not from the consequences of his own. A partner whose negligent advice causes loss is personally answerable for it, and the LLP is liable as well.

Second, where the LLP or any of its partners carries on business with intent to defraud creditors of the LLP or any other person, or for any fraudulent purpose, the liability of the LLP and of the partners who acted with that intent is unlimited for all or any of its debts or other liabilities. This applies to the partners who acted with that intent, not to innocent partners.

A related provision makes an LLP liable for the wrongful act or omission of a partner acting in the course of the business of the LLP or with its authority.

LLP distinguished from a company.

Governing statute — the LLP Act, 2008, against the Companies Act, 2013.

Internal governance — an LLP is governed by the LLP agreement, which the partners are largely free to draft as they wish. A company is governed by the Companies Act and its memorandum and articles, with far less freedom to depart from the statutory scheme.

Management — the partners of an LLP manage the business directly. A company is managed by a board of directors, who are distinct from the shareholders and owe duties to the company.

Ownership and management — combined in an LLP, separated in a company.

Compliance burden — an LLP has substantially lighter requirements: no board meetings, no general meetings, and fewer filings, with audit required only where turnover or contribution exceeds prescribed thresholds. A company must hold board and general meetings, maintain extensive statutory registers and file numerous returns, and is audited regardless of size.

Minimum capital — none is prescribed for an LLP; a company's capital structure is regulated by the Act.

Transfer of interest — a partner's economic rights in an LLP are transferable, but transfer does not by itself make the transferee a partner. Shares in a company are transferable subject to the articles, and the transferee becomes a member.

Raising capital from the public — a company may issue securities to the public if it is a public company; an LLP cannot.

Question 14

Explain how mutual agency operates as the organising idea of partnership law, tracing it through the definition, the true test, implied authority, liability to third parties, and the requirement of public notice.

Accepted Answer

Mutual agency is the single idea from which the structure of the Act follows. Each partner is at once an agent of the firm and of the other partners, and a principal bound by their acts within the ordinary course of the business.

In the definition. Section 4 defines partnership as the relation between persons who have agreed to share the profits of a business carried on by all or any of them acting for all. The closing words are the operative part. It is not the sharing of profits that constitutes partnership but the carrying on of business by any of them acting for all — that is, mutual agency written into the definition itself.

In the true test. Section 6 requires the real relation between the parties to be determined from all relevant facts, and its explanation makes clear that receipt of a share of profits is not by itself conclusive. The cases the explanation lists — a lender paid out of profits, an employee remunerated by a profit share, a deceased partner's widow taking an annuity, a seller of goodwill paid from profits — all share one feature: none of these persons can bind the business or be bound by it. They receive profits without being co-principals in the venture, and it is the absence of mutual agency that excludes them.

In implied authority. Section 19 makes the act of a partner done to carry on, in the usual way, business of the kind carried on by the firm bind the firm. That is agency stated as a rule of authority. The list of excluded acts becomes intelligible in the same frame: submitting to arbitration, compromising a claim, acquiring or transferring immovable property and entering into partnership are all outside the authority an agent for the ordinary conduct of a business would be understood to have, because none of them is carrying on the business in the usual way. Each disposes of the firm's rights or alters its constitution, and so requires the principals' express authority.

Section 20 completes the picture: partners may restrict a partner's implied authority by agreement between themselves, but the restriction does not bind a third party who deals with the firm without knowing of it. That is the ordinary rule of ostensible authority in agency, applied to firms.

In liability to third parties. Because each partner acts as agent for all, the firm is bound by contracts made within implied authority, and is liable for a partner's wrongful acts and omissions in the ordinary course of the business, and for the misapplication of money received within apparent authority. Partners are jointly and severally liable to an unlimited extent, which is the necessary consequence of having conferred on each other the power to create obligations binding on all.

The liability of a partner by holding out rests on the same foundation from the other direction: a person who represents himself as a partner has represented that he is a principal in the venture, and a third party who gives credit on that footing is entitled to hold him to it.

In public notice. A retiring partner remains liable for acts done after retirement until public notice is given. This too is agency: the appearance of authority persists until it is publicly withdrawn, and until then third parties may reasonably continue to deal with the firm on the footing that the retired partner stands behind it.

The exemptions confirm the reasoning. A sleeping partner needs no notice because no third party ever relied on his membership, so there is no appearance to withdraw. The same applies to the estate of a deceased partner and to a partner adjudicated insolvent, whose cessation is a matter of record.

The contrast with the LLP. In an LLP a partner is an agent of the LLP alone and not of the other partners, and this single change is what makes limited liability possible. Once partners are no longer each other's agents, there is no reason why one should answer without limit for another's acts, and the obligation becomes solely that of the entity.

The practical instruction for a problem is therefore to ask, at every stage, who was authorised to act for whom — because that question, and not the arrangement for sharing profits, determines the answer.

Question 15

Two chartered accountants in practice ask whether to organise as a partnership firm or as an LLP. Advise them, covering liability, compliance, continuity, registration and the practical consequences of each choice.

Accepted Answer

Liability. This is the decisive consideration for a professional practice.

In a partnership firm, every partner is jointly and severally liable to an unlimited extent for all acts of the firm done while he is a partner. A negligent audit conducted by one partner exposes the personal assets of every other partner without limit, including partners in other offices who had no involvement and no knowledge. As the practice grows, each partner's exposure grows with it while his control over the work does not.

In an LLP, a partner is not personally liable for the obligations of the LLP solely by reason of being a partner. The LLP's own property answers for its liabilities. Each partner remains personally liable for his own wrongful act or omission, which is appropriate and unavoidable, but he does not answer for his colleagues' conduct. Liability becomes unlimited only where business is carried on with intent to defraud creditors, and then only for the partners who acted with that intent.

For an audit practice, where the potential liability on a single engagement can exceed the partners' combined net worth, this difference is not marginal. It is the reason the LLP form was created and the reason most Indian firms of any size have adopted it.

Compliance. The partnership is lighter. A firm has no statutory requirement to file annual accounts or returns, and its internal affairs are governed by the partnership deed with minimal external oversight.

An LLP must maintain proper books of account, file an annual Statement of Account and Solvency and an Annual Return with the Registrar of Companies, and have its accounts audited where turnover or contribution exceeds the prescribed thresholds. Designated partners are personally liable for penalties for non-compliance.

This is a real but modest cost, and it is far below the compliance burden of a company, which requires board meetings, general meetings, extensive statutory registers and audit regardless of size.

Continuity. A firm has no perpetual succession. Subject to the partnership deed, the death or insolvency of a partner dissolves it, and every change in the partners is a reconstitution requiring the accounts to be settled and the arrangements redocumented.

An LLP has perpetual succession. Partners may come and go without affecting its existence, its rights or its liabilities, and contracts, registrations and client relationships continue uninterrupted. For a practice intended to outlast its founders, this matters considerably.

Registration and legal status. Registration of a firm is optional, but section 69 of the Partnership Act makes it practically necessary: an unregistered firm cannot sue a client for its fees, cannot claim a set-off exceeding one hundred rupees, and its partners cannot sue one another on the partnership contract — while third parties remain entirely free to sue the firm. A professional practice that cannot recover its fees by suit is not viable.

An LLP must be incorporated; it does not exist until it is. It is a body corporate and a separate legal entity, so it holds property, contracts, sues and is sued in its own name. A firm is not a separate entity, and its property is held by the partners.

Other practical consequences. An LLP requires at least two designated partners who are individuals, one of whom must be resident in India, each holding a Designated Partner Identification Number. A body corporate may be a partner in an LLP but not in a firm. An LLP has no maximum number of partners, whereas a firm is subject to the prescribed limit — relevant if the practice is expected to grow.

The ICAI permits its members in practice to form a limited liability partnership for the purpose of carrying on the profession, and audit assignments may be accepted in the LLP's name.

Recommendation. The LLP is the appropriate form. The limited liability, perpetual succession and separate legal personality are substantial advantages for a professional practice with exposure to negligence claims, and they are obtained at the cost of a modest annual filing burden that is far below that of a company. The partnership form would be preferable only for a very small practice expecting no growth and unwilling to undertake any statutory compliance, and even then the section 69 disabilities would compel registration in any event.

Practice — The Partnership Act, 1932 & the LLP Act, 2008

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