Partnerships Formation

A partnership is a business arrangement in which two or more people own an entity, and personally share in its profits, losses, and risks. The exact form of partnership used can give some protection to the partners. A partnership can be formed by a verbal agreement, with no documentation of the arrangement at all.

A partnership is an arrangement where parties, known as business partners, agree to cooperate to advance their mutual interests. The partners in a partnership may be individuals, businesses, interest-based organizations, schools, governments or combinations. Organizations may partner to increase the likelihood of each achieving their mission and to amplify their reach. A partnership may result in issuing and holding equity or may be only governed by a contract.

The Partnership Agreement

When a verbal partnership agreement is used, there may be subsequent disagreements among the owners at a later date regarding what was originally agreed to. Consequently, it makes sense to create a written document that states how certain situations are to be handled. This partnership agreement should at least cover the following topics:

• The rights and responsibilities of each partner
• Whether partners are designated as general partners or limited partners, since this impacts their responsibility for the liabilities of the partnership
• The proportions of partnership gains and losses to be apportioned to each partner
• Procedures related to the withdrawal of funds from the partnership, as well as any limitations on these withdrawals
• How key decisions are to be resolved
• Provisions regarding how to add and terminate partners
• What happens to partnership interests if a partner dies.
• What steps to follow to dissolve the partnership
• The proportions of residual cash paid out to the partners in a liquidation

Additional Partnership Formation Activities

In addition to the partnership agreement, the partners must engage in a number of other formation activities that are common to all types of businesses. These actions include:

• Register the business name
• Obtain an employer identification number
• Obtain any licenses required by governments where the partnership plans to operate, such as a sales tax license
• Open a bank account in the name of the partnership
• File an annual informational return with the Internal Revenue Service.

Forms of partnership

As common law there are two basic forms of partnership:

Limited partnership (LP): a partnership in which general partners manage the partnership’s operations, and limited partners forego the right to manage the business in exchange for limited liability for the partnership debts. The liability of limited partners is limited to their investment in the partnership.

General partnership: a partnership in which all partners manage the business and are personally liable for its debts. General partners have an obligation of strict liability to third parties injured by the Partnership. General partners may have joint liability or joint and several liability depending upon circumstances.

Silent partners

A silent partner or sleeping partner is one who still shares in the profits and losses of the business, but who is not involved in its management. Sometimes the silent partner’s interest in the business will not be publicly known. A silent partner is often an investor in the partnership, who is entitled to a share of the partnership’s profits. Silent partners may prefer to invest in limited partnerships in order to insulate their personal assets from the debts or liabilities of the partnership.

According to section 4 of the Partnership Act of 1932,”Partnership is defined as the relation between two or more persons who have agreed to share the profits of a business carried on by all or any one of them acting for all”. This definition superseded the previous definition given in section 239 of Indian Contract Act 1872 as – “Partnership is the relation which subsists between persons who have agreed to combine their property, labor, skill in some business, and to share the profits thereof between them”. The 1932 definition added the concept of mutual agency. The Indian Partnerships have the following common characteristics:

1) A partnership firm is not a legal entity apart from the partners constituting it. It has limited identity for the purpose of tax law as per section 4 of the Partnership Act of 1932.

2) Partnership is a concurrent subject. Contracts of partnerships are included in the Entry no.7 of List III of The Constitution of India (the list constitutes the subjects on which both the State government and Central (National) Government can legislate i.e. pass laws on).

3) Unlimited Liability. The major disadvantage of partnership is the unlimited liability of partners for the debts and liabilities of the firm. Any partner can bind the firm and the firm is liable for all liabilities incurred by any firm on behalf of the firm. If property of partnership firm is insufficient to meet liabilities, personal property of any partner can be attached to pay the debts of the firm.

4) Partners are Mutual Agents. The business of firm can be carried on by all or any of them acting for all. Any partner has authority to bind the firm. Act of any one partner is binding on all the partners. Thus, each partner is ‘agent’ of all the remaining partners. Hence, partners are “mutual agents”. Section 18 of the Partnership Act, 1932 says “Subject to the provisions of this Act, a partner is the agent of the firm for the purpose of the business of the firm”.

5) Oral or Written Agreements. The Partnership Act, 1932 nowhere mentions that the Partnership Agreement is to be in written or oral format. Thus, the general rule of the Contract Act applies that the contract can be ‘oral’ or ‘written’ as long as it satisfies the basic conditions of being a contract i.e. the agreement between partners is legally enforceable. A written agreement is advisable to establish existence of partnership and to prove rights and liabilities of each partner, as it is difficult to prove an oral agreement.

6) Number of Partners is minimum 2 and maximum 50 in any kind of business activities. Since partnership is ‘agreement’ there must be minimum two partners. The Partnership Act does not put any restrictions on maximum number of partners. However, section 464 of Companies Act 2013, and Rule 10 of Companies (Miscellaneous) Rules, 2014 prohibits partnership consisting of more than 50 for any businesses, unless it is registered as a company under Companies Act, 2013 or formed in pursuance of some other law. Some other law means companies and corporations formed via some other law passed by Parliament of India.

7) Mutual agency is the real test. The real test of ‘partnership firm’ is ‘mutual agency’ set by the Courts of India, i.e. whether a partner can bind the firm by his act, i.e. whether he can act as agent of all other partners.

Types of Partners

Not all partners of a firm have the same responsibilities and functions. There can be various types of partners in a partnership. Let us study the types of partners and their rights and duties.

Dormant Partner: Also known as a sleeping partner, he will not participate in the daily functioning of the business. But he will still have to make his share of contribution to the capital. In return, he will have a share in the profits. His liability will also be unlimited.

Active Partner: As the name suggests he takes active participation in the business of the firm. He contributes to the capital, has a share in the profit and also participates in the daily activities of the firm. His liability in the firm will be unlimited. And he often will act as an agent for the other partners.

Secret Partner: Here the partner’s association with the firm is not public knowledge. He will not represent the firm to outside agents or parties. Other than this his participation with respect to capital, profits, management and liability will be the same as all the other partners.

Partner by Estoppel: If a person makes it out to be, through their conduct or behaviour, that they are partners in a firm and he does not correct them, then he becomes a partner by estoppel. However, this partner too will have unlimited liability.

Nominal Partner: This partner is only a partner in name. He allows the firm to use the name of his firm, and the attached goodwill. But he in no way contributes to the capital and hence has no share in the profits. He does not involve himself in the firm’s business. But his liability too will be unlimited.

Importance of Registering a Partnership Firm

The registration of a partnership firm is optional and not compulsory under the Indian Partnership Act. It is at the discretion of the partners and voluntary. The firm’s registration can be done at the time of its formation or incorporation or during the continuance of the partnership business.

However, it is always advisable to register the partnership firm as a registered firm enjoys certain special rights and benefits as compared to the unregistered firms. The benefits that a partnership firm enjoy are:

A partner can sue against any partner or the partnership firm for enforcing his rights arising from a contract against the partner or the firm. In the case of an unregistered partnership firm, partners cannot sue against the firm or other partners to enforce his right.

The registered firm can file a suit against any third party for enforcing a right from a contract. In the case of an unregistered firm, it cannot file a suit against any third party to enforce a right. However, any third party can file a suit against the unregistered firm.

The registered firm can claim set-off or other proceedings to enforce a right arising from a contract. The unregistered firm cannot claim set off in any proceedings against it.

Procedure for Registering a Partnership Firm

Step 1: Application for Registration

An application form has to be filed to the Registrar of Firms of the State in which the firm is situated along with prescribed fees. The registration application has to be signed and verified by all the partners or their agents.

The application can be sent to the Registrar of Firms through post or by physical delivery, which contains the following details:

• The name of the firm.
• The principal place of business of the firm.
• The location of any other places where the firm carries on business.
• The date of joining of each partner.
• The names and permanent addresses of all the partners.
• The duration of the firm.

Step 2: Selection of Name of the Partnership Firm

Any name can be given to a partnership firm. But certain conditions need to be followed while selecting the name:

• The name should not contain words like emperor, crown, empress, empire or any other words which show sanction or approval of the government.
• The name should not be too similar or identical to an existing firm doing the same business.

Step 3: Certificate of Registration

If the Registrar is satisfied with the registration application and the documents, he will register the firm in the Register of Firms and issue the Registration Certificate. The Register of Firms contains up-to-date information on all firms, and anybody can view it upon payment of certain fees.

An application form along with fees is to be submitted to the Registrar of Firms of the State in which the firm is situated. The application has to be signed by all partners or their agents.

Documents for Registration of Partnership

The documents required to be submitted to Registrar for registration of a Partnership Firm are:

• Application for registration of partnership (Form 1)
• Certified original copy of Partnership Deed.
• Specimen of an affidavit certifying all the details mentioned in the partnership deed and documents are correct.
• PAN Card and address proof of the partners.
• Proof of principal place of business of the firm (ownership documents or rental/lease agreement).