Reconstitution of a Partnership Firm

Reconstitution of a Partnership Firm

Partnership Firm means an association of two or more that two people who form an organization for the purpose of doing business and earning profit. Partnership Act, 1932 defines partnership as – 

“Relation between persons who have agreed to share the profits of a business carried on by all or any of them acting for all”.

 All the members are collectively called a ‘partnership firm’ and individually they are called ‘partners’. All the members have a relation of mutual agency [i]and they share profit as well as losses incurred by the firm.

 Any changes in the constitution of the firm or change in relation of partners or restructuring of the partnership firm is called ‘reconstitution of the firm’. By reconstitution of the firm the pre-existing agreement between the partners comes to an end and a new agreement arises among them. Reconstitution of the partnership firm can take place due to many conditions such as by consent of all partners for change or because of some contingency or by admission or removal of a partner.

Modes of Reconstitution of a Partnership Firm 

A partnership firm can be reconstituted by the following modes  –

• Admission of a new partner
• Retirement of a partner
• Expulsion of a partner
• Insolvency of a partner
• Death of a partner
• Change in profit sharing ratio among partners

• Admission of a new partner –

  A partnership firm can admit a new partner to the firm by mutual consent. According to Section 31 of Partnership Act, 1932 a person may be introduced to the partnership firm in the following ways –

i). With consent of all the existing partners

ii). In conformity with the agreement between the partners and the provision of partnership deed 

 Illustration – A, B and C were three partners running a firm. B introduced D to the firm with the intent of admitting him to the partnership firm.

Case I – All the partners unanimously agreed to admit D to the firm and thereby reconstitution of firm took place and now there are four partners in the firm.

Case II – C opposed the admission of D to the firm. Now, as there is no unanimous consent of all the partners, D can not be admitted to the firm and there will be no reconstitution of the firm.

 The new admitted partner is called ‘incoming partner’. The date of admission of the incoming partner is the date when notice regarding his joining the firm is made public.

 Liability of the new partner – The new partner is not liable for the acts of the firm and other partners unless he becomes a partner in the firm according to deed and his admission is declared in public. All the liabilities incurred by the firm prior to his admission will not bind him unless he agrees to take them by an agreement with consent of all the partners.

• Retirement of a partner –

  Retirement of a partner is said to happen when a partner willfully decides to leave the firm. A partner may retire due to poor health, change in nature of business or any other reason. Remaining partners continue to carry on the business of the firm. Section 32 of Partnership Act, 1932 provides that a partner may retire by any of the listed below ways – 

i). With consent of all the partners

ii). In accordance of the agreement between the partners

iii). In case of partnership at will[ii], by giving proper notice, in writing and signed by the retiring partner, the notice should be communicated to all the partners regarding his intention to retire from the firm.

Illustration – A, B and C are three partners of a firm. C due to some reasons decides to retire from the firm.

Case I – C may retire after getting the consent of all the other partners in the firm regarding his retirement.

Case II – If there is partnership at will, then C will have to give a notice in writing and signed by him to all the partners showing his intention to retire from the firm. 

The retiring partner is called an ‘outgoing partner’. Date of retirement is the date on which the notice is communicated to all the partners or if the date is mentioned in the notice then retirement shall be deemed to have effect on the date mentioned. For persons other than partners it is the date on which the notice of retirement of the partner is made public.

 Liability of the retiring partner – A partner after retiring from the firm continues to be liable for his acts or liabilities incurred during the tenure of his partnership in the firm. However, he may by be discharged if – 

i). When the partners of the reconstituted firm decide to take over his liability

ii). When the third party decides to set free the retiring partner and accepts the partners of the new firm as the debtors.

 After retirement, there is no liability of the retired partner for the acts or debts of the firm.

• Expulsion of a partner –

  Expulsion of a partner means exclusion of the partner from the firm by mutual consent of the partners. The expulsion of a partner may take because of reasons like poor conduct, for welfare of firm, etc. Section 33 of Partnership Act, 1932 lays down the following conditions for the expulsion of a partner – 

i). When the partnership deed confers power o the partners to expel the partner

ii). The power to expel the partner must be exercised by majority of partners and should not be arbitrary 

iii). The power to expel must be exercised in good faith.

Illustration – A, a partner of the firm having B, C and D as co-partners was found to be indulged in some immoral activities which in return were affecting the image of the firm in society. B, C and D decided to expel A from the firm in good faith.

 Liabilities of the expelled partner –  A partner after being expelled from the firm continues to be liable for his acts or liabilities incurred during the tenure of his partnership in the firm. However, he may by be discharged if – 

i). When the partners of the reconstituted firm decide to take over his liability

ii). When the third party decides to set free the retiring partner and accepts the partners of the new firm as the debtors.

 After being expelled from the firm, there is no liability of the expelled partner for the acts or debts of the firm.

• Insolvency of a partner –

   When a partner is adjudicated as insolvent[iii] he ceases to be a partner of the firm from the date on which such adjudication is made. According to Section 34 of Partnership Act, 1932 the effects of insolvency of a partner are as follows – 

i). The insolvent partner ceases to be partner of the firm from the date of being insolvent

ii). The firm is dissolved on the adjudication of insolvency of any partner in absence of any contract to the contrary.

No notice of insolvency of the partner is required to be given either to the partners or to the public.

• Death of a partner –

   A partner ceases to be a partner of the firm on his death. Section 42 of Partnership Act, 1932 provides that a firm shall be dissolved on the death of a partner subject to the contract to the contrary.

 Liability of the deceased partner – On death, the estate of the deceased partner is liable for his acts done or liabilities incurred before his death. 

 If the firm agrees to continue business after the death of the partner, there is no liability of the deceased partner or his estate.

 No public notice is to be given on the death of a partner.

•  Change in profit sharing ratio among partners –

  A partnership firm has a decided and fixed ratio of profit sharing. If the partners with mutual consent decide to change the profit sharing ratio of the firm then it will amount to reconstitution of the firm. A new partnership deed will be formed with a new profit sharing ratio and the previous ratio will stand null and void.

Illustration – A, B, C and D were partners in a firm having profit sharing ratio as 2:2:1:2. Due to some conditions they decide to alter the profit sharing ratio and alter it by making it as 2:3:1:2. This will amount to novaton of the firm and now a new contract will be formed.

Effects of Reconstitution of Firm

 Effects of reconstitution of firm may be –

• Change in mutual right and duties
• Revocation of continuing guarantee 

• Change in mutual right and duties –

  Section 17(c) of the PArtnership Act, 1932 says that on reconstitution of the firm the rights and duties of the partners remain the same as they were before the reconstitution. 

• Revocation of continuing guarantee –

   Section 38 of the PArtnership Act, 1932 says that on reconstitution of the firm the continuing guarantee given on behalf of the firm or to the firm stands revoked as to future transactions from the date of reconstitution.

 Conclusion 

 Reconstitution of a firm may take place through admission of a partner, retirement of a partner, expulsion of a partner, insolvency of a partner, death of a partner or change in the profit sharing ratio. In case of death and insolvency the firm may be dissolved in absence of contract to the contrary. Reconstitution causes formation of a new contract between the existing or new partners. 

[i] One acting for all OR acts of one partner can bind all the others for the liability incurred

[ii] There is no fixed time period for the partnership

[iii] A person who is no longer able to pay his debt or liability

Author: Poorva G Chaturvedi,
Modi Law College, Kota