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Formation of Partnership is an important activity which has to take place within the tenets of the law. The permissible restrictions are present in the Indian Partnership Act, 1932. The agreement through which the partnership is originated is to be legal and the object should not be illegal. The partnership is not created by status and can be at will.
I. Introduction – Formation of Partnership
Partnership is an association whereby the partners have agreed to share their profits and hence carry on the business accordingly. Each partner agrees and has to act as an agent of the partnership firm. There has to be intent to carry on a business which is the sole and the most important requirement for entering into a partnership.
II. Partnership Agreement
The Partnership Agreement is the source of the relationship of partnership. The construction and interpretation of such an agreement is done through ascertainment of natural and ordinary meaning of the words used in the contract unless the meaning leads to absurdity.
The cardinal principle of interpretation in understanding such an agreement is that it has to be interpreted reasonably. The terms of the agreement showcase the intention of the parties along with which the surrounding circumstances, like management and finance are to be collectively considered.
Agreement is mandatory to be entered into among persons concerned, who would be later transformed into partners. The agreement is not to be necessarily express, it can be implied. The contract can also be oral or written. In the landmark case of Niadar Mal Jagdish Parshad v. Commissioner of Income-Tax, the partnership agreement by virtue of an oral agreement was given due recognition and validity.
No formation by virtue of status
Section 5 of the Indian Partnership Act, 1932 is very categorical in terms of laying down the position of law. It clearly states that partnership is created by contract and not status. Two particular examples are given, that are, Hindu Undivided Family (HUF) and a Burmese Buddhist Husband and wife carrying on business together.
Importance of a contract
The position has been confirmed by judicial decisions where it is held that the appropriate way to form partnership is through a contract. And it cannot happen by virtue of status. An agreement is an essential component and the lifeline of the partnership. This shows that personal contacts, blood relationships and natural relations cannot lead to the formation of partnership.
Difference with Co-Ownership
Only because two persons are co-owners of an estate, they would not become partners. The estate can be some chattel, for example, a ship. They may develop a business over the land and have mutual profit. Thus means they may carry the business with respect to the same chattel but this association would not transpose into a relation of partnership.
This shows how the status of the business is different from that of a partnership. Thus jurisprudential principle forms the basis of the section 5 mentioned above. For example, a joint venture for purchase and resale of potatoes on one occasion only, can be a business and not a partnership.
Joint Hindu Family Business
A Joint Hindu Family in substance has a legal personality as through its Karta, it can enter into legal relationships like a contract with third parties. By that logic, members of such family should also be allowed to be partners in respect of their properties that would amount to be the capital. The Law nowhere prevents them to do so. If the members are trading in something, they can have an agreement for a partnership.
Then the confusion may arise as to why the restriction for HUF in partnership law? Actually it is prohibiting formation of partnership of the members of the HUF with the strangers. The plain reason for the same is that in a partnership, the relationship exists inter se partners also. Thus, if strangers are allowed to be partners, it would strike the very root of the HUF.
Only because some or all of the coparceners are members of a firm, the HUF does not transpose into a Hindu Joint Undivided Firm. Hindu Undivided Family or a Joint Hindu Family is not a juristic person for all purposes. The trade carried ancestrally through Hindu family is different from the business carried through partnership. It is because the former is known as the Hindu Joint Undivided Firm which does not need any partnership agreement.
The difference between the two can expiated further. Two essential differences are-
- Joint Family Trading Partnership is not dissolved by the death of the member. Partnership by contract dissolves with the death of a partner.
- Member of the family, if eligible under law, would become coparcener by operation of law. In a partnership created by contract, the members become the partners by choice.
- A Joint Hindu Family is single person. Partnership by contract is a relation that subsists between different persons.
- A Joint Hindu Family is a unit that cannot be admitted into by agreement since it is a creation by status. The status would be acquired either by birth or adoption. But, the partnership by contract can be entered into through an agreement.
- Essence of HUF is Unity of ownership and community of interest where no member can claim that he is the owner of a specific portion like one third or one fourth of the property. But in a partnership by contract, the shares of the members are well defined.
- In Joint Hindu Family business the individual losses and profits is not worked out whereas in the case of partnership accounts, it has to be worked out.
Divided members from the Joint Hindu Family can enter into relation of partnership with strangers. In such a case the provisions of Indian Partnership Act would be the governing law. The share of the divided members in the interest of their representative in the partnership would depend upon the terms of the partition deed.
If the manager of a joint Hindu Family has entered into a partnership with a stranger, it is not considered that the entire family as a person is a member of the firm. Thus, it is true that two joint Hindu families cannot enter into partnership with each other, but their managers certainly can and thus, each would be having rights and duties with reference to their respective families.
On similar lines, individual members of one joint Hindu Family can enter into partnership with the individual members of the other joint Hindu family. But, as said above, it not allowed for the entire family to be taken as a member.
III. Partnership At Will
Once a partnership is formed by its only method that is of a contract, but, the duration of the partnership is not stipulated in the contract, the partnership is called “partnership at will”. Thus, it becomes open to each partner that or she can dissolve the partnership at any time by the act of just providing a notice.
For the formation of partnership by such an approach has led to various approaches and guidelines formulated by the courts. As the provision states that if there is no term in the partnership deed regarding determination of partnership, it would be then termed as partnership at will.
Now the question arises as to how and in what situations this interpretation is made. In one case, the approach of the court was that if there is a provision for retirement of a partner, it does not become a provision for determination. Thus the partnership can be considered that at the will.
In another case, where the managing partner was given vast powers to run the firm and remove the partner, it is not considered as a partnership at will. It was because the circumstance and effect of various other clauses in the partnership deed would have to be considered.
Another provision in another partnership deed stated that the partnership will continue till there are two partners. Hon’ble Supreme Court held that such a provision in the agreement does not indicate that the partnership is at will. Similarly, the provision allowing a partner to relinquish his interest would not make the partnership as will.
On the other hand, in the absence of any provision regarding the duration of partnership, if one partner is absent, the partnership of more than two partners is considered as a partnership at will.
Name of the firm
To carry on the business, the most important and the common instrument through which there can be an interaction with the customers is the very name of the firm. As it is earlier said, that the firm is the collective name for the partners to act and carry on business. It is very crucial for the partners to choose their name wisely in order to form their partnership appropriately.
In common law, the principles relating to partnership are well settled as there is a great amount of latitude given to the partners so as to use their personal name so as long as they are not used for deceptive purposes. Hence, partners are permitted to carry on the business under any name and style they like and chose to adopt.
Choosing a name
If there is no provision of law prohibiting the usage of similar and identical name, the firm can be registered with a similar or identical name. It is because the act contains no restriction on the usage of such a similar and identical name. There is no provision that empowers the Registrar to refuse the registration.
But the liberty ends at the step when the firm tends to mislead the public with its name similar to that of the other firm. The conduct can also comprise of showing that the goods manufactured by one firm are those of the other firm. This is atypical passing off action whereby one person through the trade trends to appropriate and manipulate the reputation of another person.
The settled position of law is that- “A statement which is literally true, but which is intended to convey a false impression, has something of a faulty thing about it; it is not sterling coin; it has no right to genuine stamp and impress of truth.”
Hence even if the defendant is honest and the usage of the word by him or her is his or her own name, even in such a case, if the usage of the word leads to confusion and misleads the public, it is not allowed. There is no special burden of proof laid upon the plaintiff by the fact that the word used by defendant is his or her own.
The change of a name of a firm does not affect the rights and liabilities of a firm. But there must not be a change in the membership of the firm so that the proposition holds good. A name cannot be sold in the market like a commodity without the use that may be made of it.
IV. Illegality in Formation
Section 23 of the Indian Contract Act prohibits and declares such agreements with unlawful consideration as void. The same logic applies to partnership agreements. The object of the partnership has to be proved to be legal. It can be the object involved or necessarily involved.
In case there is an illegality, accordingly found, in the partnership, then there is left no reason for the partnership to be not sued. But the person who is suing the firm needs to meet the standards laid down by equity and law. He or she should not have a turpi cause and should not be a particeps criminis. It means that the person who is bringing the suit is bona fide and did not have notice of the illegality.
Thus no suit can be filed for recovery of the amount invested in an illegal partnership. In such cases, where the partnership itself is unlawful by virtue of having a void object, the courts would not be able to help the plaintiff.
But what is illegal or what is not, it is not the contract which would decide the same. It is for the law and the courts that are the final decision-makers. For example- if the contract prohibited the person from entering into relation of assignment with the person if the person does so, it does not become an illegal act.
Conclusion – Formation of Partnership
The formation of partnership is a process covered under the tenets of the Indian Partnership Act. The object of such a partnership needs to be lawful and within the permissible limits of law.
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