Change in Partners (Appointment or Removal)
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Change in Partners (Appointment or Removal)
Any minor alterations in the partnership structure of a firm require reorganization. Adding a new partner or removing an existing one necessitates the firm’s reconstruction. Therefore, the addition or removal of a partner cannot occur without the consent of all current partners, unless otherwise stipulated in a partnership agreement or regulations concerning minors in the firm. This article discusses the legal implications of adding and removing partners in a partnership firm under the Indian Partnership Act of 1932.
Introduction of a New Partner (Section 31)
The admission of a new partner into a partnership business requires the knowledge and approval of the existing partners as a fundamental principle of partnership formation.
Rights and Liabilities of a New Partner
A new partner’s liabilities in a partnership firm typically commence from the date of their admission, unless they choose to assume responsibility for the firm’s prior obligations. Creditors may agree to consider the new partnership liable for existing debts if the new partner and the firm agree to take on such obligations. Such agreements, termed novations, legally substitute liabilities in contracts, although they are not restricted to partnerships.
However, a mere agreement among partners that the incoming partner will bear existing debts does not automatically bind creditors to this arrangement.
This provision does not apply to partnerships of two partners because the partnership automatically dissolves upon the death of one partner. In such cases, admitting a new partner requires unanimous consent from the remaining partner(s).
Rights of the Outgoing Partner
Upon leaving, a partner retains certain rights.
Right to Carry on Competing Business (Section 36)
A departing partner may engage in a competing business but cannot use the firm’s name or represent themselves as continuing the firm’s business without a contract stating otherwise. Section 36(1) allows seeking clients from the firm they left, subject to certain restrictions. While this provision limits an outgoing partner’s actions, it permits them to engage in competitive activities.
The partners may agree that upon ceasing to be a partner, the departing partner will refrain from engaging in a business similar to the firm’s for a specified period or within certain geographical limits. Section 36(2) specifies that such agreements are not considered restraint of trade if deemed reasonable.
Right to Share in Assets
Upon leaving the firm, a partner is entitled to their share of the firm’s assets, including goodwill. In the absence of any established contrary usage, assets should be valued at their fair market value on the date of settlement, rather than at book value.
Right to Claim (Section 37)
If the remaining partners continue using the firm’s assets without settling accounts with the departing partner, the outgoing partner has a claim against the firm. Upon ceasing to be a partner, they are entitled to their share of profits from the use of firm assets, with an option to claim interest at 6% per annum on any unsettled portion.
If the partnership agreement includes an option for continuing partners to buy out the departing partner’s interest, exercising this option prevents the outgoing partner or their estate from future profit sharing. Failure to comply with the terms of such an agreement may result in liability under Section requirements.
Liabilities of the Outgoing Partner
A departing partner remains liable in several ways.
Liability to Third Parties (Section 32(3) and (4))
Unless a public notice of retirement is given by the partner or remaining partners, a departing partner remains liable to third parties for the firm’s actions even after leaving. However, they are not liable to parties unaware of their former partnership status.
Agreement on Liability (Section 32(2))
Until a public notice of retirement is issued, a departing partner remains liable to third parties unless an agreement stating otherwise exists among the departing partner, remaining partners, and affected third parties. Such agreements can imply consent through subsequent dealings between third parties and the reconstituted firm after notification of retirement.
If the partnership is at-will, retirement can be effective without public notice upon written notification to all partners.
Expulsion of a Partner (Section 33)
A partner may be expelled for various reasons, but expulsion is only valid if it meets the following criteria based on a contract between the partners:
- The expulsion authority must be specified in the partnership agreement.
- A majority of partners must exercise this authority.
- Expulsion must be in good faith, including notifying the partner and giving them a chance to be heard.
Failure to meet these criteria renders an expulsion invalid and may lead to judicial dissolution rather than automatic partnership termination.
Insolvency of a Partner (Section 34)
If a partner is declared insolvent, they cease to be a partner from the date of the adjudication order. Consequently, the partner’s estate is not liable for the firm’s actions after this date, nor is the firm liable for the partner’s actions.
Effects of Insolvency
Insolvency generally leads to partnership dissolution unless agreed otherwise by the partners. However, partners can agree that a partner’s insolvency will not dissolve the firm.
Death of a Partner (Section 35)
Unless otherwise agreed, the death of a partner generally leads to partnership dissolution, especially in partnerships with two partners. However, partners can agree that a partner’s death will not dissolve the firm, allowing it to continue as per the agreed terms without public notification or release from future obligations related to the deceased partner’s estate.
Revocation of Continuing Guarantee (Section 38)
A continuing guarantee granted in connection with a partnership’s transactions is revoked for future transactions upon any changes to the partnership structure unless otherwise agreed. Section 38 of the Indian Partnership Act outlines this provision, emphasizing the need for clear agreements to override its effects.
