Partnership Firm Disputes: Dissolution, Accounts and a Cheating Partner

A partnership firm is the simplest business structure and often the most fragile. Partners start with trust and a handshake, and when that breaks down they discover how little is written. The Indian Partnership Act, 1932 fills the gaps, and for many partnership disputes it is the first thing a court will look at. This article deals with traditional partnership firms. A Limited Liability Partnership is governed by a different statute and by its own agreement.

What Governs the Relationship Between Partners?

The partnership deed, if there is one, comes first, and the Act applies where the deed is silent. Every partner is an agent of the firm and of the other partners for the firm's business, and partners are jointly and severally liable for the firm's acts. Partners owe each other duties of good faith and must render true accounts. Under Section 16, a partner who carries on a competing business without the others' consent must account for the profits made and pay them to the firm, and a partner who makes a secret profit from the firm's business must account for it.

Can an Unregistered Firm Sue?

Registration of a firm is optional, but Section 69 limits the rights of an unregistered firm. Neither the firm nor a partner can sue a third party to enforce a right arising from a contract, and a partner cannot sue the firm or another partner to enforce a right under the Act or the deed, unless the firm is registered. There are important exceptions in Section 69(3), which allow a suit for dissolution of the firm, for accounts of a dissolved firm, and for realisation of the property of a dissolved firm. A partner in an unregistered firm can therefore still ask the court to dissolve it and take accounts.

How Can a Firm Be Dissolved?

The Act provides several routes:

• By agreement between all partners, under Section 40
• By written notice, if the firm is a partnership at will, under Section 43
• On events such as expiry of a fixed term, death or insolvency of a partner, unless the deed says otherwise
• Compulsorily, where the business becomes unlawful or all but one partner become insolvent
• By the court, on grounds listed in Section 44

Under Section 44, the court can dissolve a firm on the suit of a partner where, for example, a partner has become of unsound mind or permanently incapable of performing duties, a partner is guilty of misconduct likely to affect the business, a partner persistently breaches the agreement or conducts affairs so that it is not reasonably practicable to carry on business with them, the business can only be carried on at a loss, or the court finds it just and equitable. Allegations of cheating and diversion of funds usually fall within misconduct and the just and equitable ground.

What Happens to Accounts After Dissolution?

Dissolution is only the start of the winding-up. Sections 46 to 55 deal with the consequences. Each partner can require the firm's property to be applied to pay its debts and liabilities, and the surplus is distributed among the partners. Under Section 48, unless the deed provides otherwise, losses including deficiencies of capital are paid first out of profits, then out of capital, and lastly by the partners in their profit-sharing ratio. The assets of the firm are applied in this order:

• Paying the debts of the firm to third parties
• Repaying each partner their advances to the firm, apart from capital
• Repaying each partner's capital
• Dividing any balance among the partners in the proportion in which they share profits

Goodwill is treated as an asset of the firm and is sold along with its other property unless the deed says otherwise, and after dissolution each partner can restrain the others from using the firm name or property for their own purposes. A partner who retires or whose partnership ends remains liable for acts of the firm before retirement until public notice of the retirement is given, so retiring partners should give notice and have it recorded.

What Can You Do About a Partner Who Cheats the Firm?

The civil remedies are usually the most effective, and they are as follows:

• A suit for dissolution and rendition of accounts, which forces the partner to account for funds and profits
• An injunction restraining the partner from dealing with firm assets, bank accounts or customers
• Appointment of a receiver under Order XL of the CPC to take control of the firm's property pending the suit
• A claim for the firm's share of any secret profits, with interest
• Recovery of the amount misappropriated, along with damages

The suit for accounts is the core remedy, and the court usually passes a preliminary decree directing accounts to be taken and then a final decree on the result. Forensic accounting is often needed, since cheating partners rarely keep honest records. A receiver is appropriate where there is a real risk that assets will be dissipated; courts require evidence and not suspicion.

What About a Police Complaint?

Where there is real misappropriation, criminal breach of trust and cheating provisions of the Bharatiya Nyaya Sanhita may apply. But the courts have repeatedly warned against using criminal complaints as a way of settling what is essentially a civil dispute between partners, and complaints that are really about accounts are often quashed. A complaint is better supported where there are clear facts of forgery, fake entries or diversion of funds to a personal account. The civil suit should run alongside it and not be replaced by it.

Does an Arbitration Clause Matter?

Many partnership deeds contain an arbitration clause. Where it does, the court will refer disputes covered by the clause to arbitration if a party applies in time, and the arbitrator can order accounts. Whether a dissolution decree can be passed by an arbitrator is a more difficult question, and the court may be asked to decide it, so partners should review the deed before choosing the forum. Our guide to arbitration clauses and Sections 8 and 9 explains the position.

How Can Partners Avoid These Disputes?

A written partnership deed that covers capital, profit sharing, powers, banking authority, retirement, exit, valuation of a retiring partner's share and dispute resolution avoids most disputes. The firm should keep proper books, reconcile accounts regularly, and register itself. And when relations start to break down, partners should avoid unilateral acts such as withdrawing money or locking out others, because those acts will count against them.

Partnership disputes turn on the deed, the accounts and the conduct of the partners. Our Commercial Disputes practice advises partners on dissolution, accounts and recovery, and you can request a consultation. For the company equivalent of a partnership breakdown, see our note on oppression and mismanagement.