Test of Partnership: Explanation, Components & Case Laws

By | April 5, 2020
Test of Partnership

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Test of Partnership has to be carefully applied by the courts so as to judge whether a given relation is that of a firm or not. It is to investigate the real intention of the partners. A mere fact of the share of profits would not make the relation that of a partnership.

I. Introduction

Partnership stands for a relation between the partners where they agree to collaborate and carry on a business together. [1] As it is well known, that such a group of partners is well known as a firm together. The firm is a mere compendious name to denote the existence of the relation of partnership. [2]

It is a clear position of law that a partnership firm is not a legal entity.[3] As mentioned above, it is a mere reference to the existence of the relationship of partnership. Thus, the question arises that in what situations would a specific relation be considered as that of the partnership?

Indian Partnership Act (hereinafter “The Act”) provides the answer to such question. In the present article, such provisions and legal nuances of the test of partnership would be discussed in detail. The perusal of the following text would clear all doubts pertaining to the same and help in coming to the conclusion faster as to whether a given relation is a partnership or not.

II. Statutory Exposition

In Section 6 of the act, the mode of determining the existence of partnership is clearly provided. It says that the correct mode or test is by regarding the “real relation between the partners”. For this exercise, “all the relevant facts” have to be considered together.[4]

In the Explanation, it is provided that sharing of profits and receiving the share of profits would not make the relation itself that of the partnership. There are certain specific instances provided in Explanation 2 particularly, whereby the receipt of the share of the payment would not make the relation as that of the partnership. Such instances are- receipt by-

  • by a lender of money to persons engaged or about to engage in any business,
  • by a servant or agent as remuneration,
  • by the widow or child of a deceased partner, as an annuity, or
  • by a previous owner or part-owner of the business, as consideration for the sale of the goodwill or share thereof”

Hence, the entire picture has to be fathomed before jumping to the conclusion that a particular relation is that of the partnership. All the relevant facts should be considered by the court and not even a single material consideration should be left out from its purview.[5]

III. History

Such a provision did not exist in the English Partnership Act. It is shown from the common opinion that was existent in English jurisprudence that sharing of profits is not mere evidence rather conclusive evidence of a partnership. This view was totally discarded in the landmark case of Cox v. Hickman.[6]

It was held that only because, there is a presence of sharing of profits, the job is not finished. The court is not made free from delving further into the question of whether the relation amounts to the partnership. There is no special rule existent that precludes the courts from considering relevant facts in adjudging such a proposition.[7]

On the other hand, the English Act of Partnership gives sundry examples of the erroneous opinion about the sharing of profits and does not empower the courts that universal principles decided from a case law have to be applied in such partnership cases.[8]

Privy Council in the landmark case of Mollwo, March & Co v. Court of Wards[9], refined the position further. In this case, a third party was given, in consideration of advances, a commission in the net profits of the partnership business. Large power of control of the business was also given to this party for its protection.

It held that the fact of participation in the profits of trade can give rise to a presumption of fact that there exists the relation of partnership. But the final decision of whether the relation exists or not depends on two things-

  • “Real Intention of Parties
  • Conduct of Parties”[10]

Hence the relation was not held to be that of the partner and the firm rather that of a lender and creditor. In another case of underwriting business between A and Z, A agreed to pay Z some portion of his profits. It was in consideration of guarantee by Z for the underwriting business of A.

Such a relation where profits were being shared was not held to be that of a partnership but, it was a mere settlement for a guaranteed purpose.[11]

IV. Broad Parameters – Test of Partnership

Hon’ble Supreme Court in the landmark case of Helper Girdharbhai v. Saiyed Mohd Mirasaheb Kadri[12] has laid down the parameters which have to be considered for coming to the conclusion whether a particular relation is that of the partnership or not. The court preliminary held it to be mixed question of law and fact.

The crucial elements to be considered for adjudging a relation as that of a partnership are-

  • There must be an agreement entered into by all parties concerned[13]
  • Agreement must be to share profits of business[14]
  • Business must be carried on by all or any of the persons concerned acting for all.[15]

To reach a conclusion whether a particular relation is that of the partnership or not, there a multiple factors which court weighs before concluding upon the same-

  • “Parties have not retained any record of terms and conditions of partnership.
  • Partnership business has maintained no accounts of its own, which would be open to inspection by both parties
  • No account of the partnership was opened with any bank
  • No written intimation was conveyed to the Deputy Director of Procurement with respect to the newly created partnership.”[16]

This shows that the court would infer the real intention of the parties through their conduct. If they are so serious of maintaining a relation of partnership, they should at least do their basic part of having an agreement and having some record of the same. Having an account in the bank and intimating about the same to the authorities would also be required.

Hence, the court is bound to take in all the circumstances related to a case along with the conduct of the parties.[17] It leads to the general consensus that questions whether a concern is a firm or not, is a question of fact ordinarily.[18] Certain kinds of facts would not be sufficient to establish partnership; hence they would have to be considered in totality.

For a court, the facts would have to be understood and interpreted as a sensible man of business would interpret them. Then only the court should give rest to its test whether a concern is a partnership firm or not.[19]

V. Specific Components of the Test of Partnership

1. Mutual Agency

Mutual Agency is a strong test which indicates and proves whether a relation is that of partnership or not. It has been categorically held and supported by judicial precedents.[20]

Such mutuality means that partner is entitled to equal share of profits, interest payable out of profits, 6% per annum interest for payment beyond amount of capital, indemnification from firm and for wilful neglect in conduct, partner shall also indemnify firm. A partner is not entitled for remuneration.[21]

2. Sharing of Profits

There are instances where the presence of sharing of profits has been considered to be a strong test of the existence of a partnership.[22] It gives rise to a presumption about the existence of a partnership.[23] It is agreed that the historical evolution of the law began from the discarding of the erroneous belief prevalent in England that sharing of profits is conclusive proof of partnership.[24]

But, it should not be denied that even in the present jurisprudence governing partnership, sharing of profits is considered as a very strong test of partnership and also considerably strong evidence to prove the same.[25] It is true, but, that payment of contingent would not change the position of a person to a partner.[26]

3. Contribution of Capital is not required

It is also well settled that for constituting a valid partnership, partner need not contribute capital. It means that contribution of partnership would not be considered as a sine qua non of partnership.[27]

4. Agreement among partners

It is a mandatory requirement when it comes to the relation of partnership. But, its construction is to be effected with the jurisprudential requirement of construing it as a whole.[28] Only because, in an agreement among the partners, they have described themselves as having a relation of partnership, it would not suffice.

Only a reference to partnership and a mere description is not sufficient to constitute a relation of partnership. It is, hence, not conclusive evidence of the same.[29]

The importance of an agreement one can fathom from its need in case of a dispute inter se partners. It is a well-settled position of law that an agreement of partnership has precedence over any oral account or version of such an association.[30]

VI. Non- Essential Components of Test of Partnership

1. Sub-letting

It has to be distinguished from the relation of partnership carefully. It is because in situations of simple sub-letting of premises by one person to the other would not mean that a partnership firm is in existence.[31] But, one has to be careful. What may seem to be a mere case of sub-letting can be a case of a partnership.[32]

Hence the answer can be gathered from the purported agreement. In case, the court finds that behind the guise of this agreement, a real transaction which is different in nature is being hidden, lifting of the veil can be done. It means that the court can lift the veil of partnership to find out the real nature of the transaction. [33]

On similar lines, thus, courts can tear the veil of partnership too, so as to know whether there is any sub-letting or not.[34] As per the broad guidelines laid down by Hon’ble Supreme Court, parting with possession of tenancy and it being done without the consent of the landlord in lieu of compensation or rent, both these essentials have to be established for sub-letting to be proven.[35]

2. Sub- Partnership

When assessing the validity of partnership and its existence, there come perplexing situations before the court. One such situation is when some partners of a firm collaborate for a distinct business in a separate partnership.

This fact of a sub- partnership is not at all prohibited in the statute. Only because there is a sub- partnership, the validity of the partnership would not be affected. It would also not affect the manner of sharing of profits in the original partnership

Hence, to assess the existence of a partnership having a sub- partnership, the fact of the latter has no relevance in the question of the former.[36]

3. Salary for a partner

In case, in a firm, a partner gets a salary for the services he renders, it becomes difficult to differentiate between share of profits and payment of salary. Thus, it is generally agreed that a salaried partner in a firm may or may not be a partner depending upon the substance of the true relationship.[37]

In many cases, either opinion looks justifiable. There is a landmark case wherein, an owner of a ship used to pay fixed wages to a master for the management of his ship. One day, he handed over the entire management of the ship to the master, on the condition of getting a fixed share of profits from him.

When the court confronted with this question on whether there exists a relation of partnership or not, the court considered that master can be given the status of a partner. But, it can also be considered as a relationship of master-servant, wherein, the servant has been given huge discretion by his or her master.[38]

In another case of managing the business of wagons, A was carrying on the business of loading and unloading in a limited company. He appointed B for management purposes and agreed to give 12 annas out of net profits as remuneration. A was also supposed to get 4 annas as a share of the profits.

Such a relationship was adjudged to be a mere principal-agent relationship and not that of the partnership because of the absence of any mutual agency.

VII. Conclusion – Test of Partnership

All the tests of the partnership have to be considered collectively and together. Since it is majorly a question of fact, the court is duty-bound to consider all the relevant facts and then come to a conclusion whether a particular relation is that of partnership or not.

[1] Indian Partnership Act, 1932, § 4, No. 9, Acts of Imperial Legislature, 1932 (India).

[2] Deoha F. Guzdar v. C.I.T., AIR 1955 SC 74.

[3] Indian Oil Corporation Ltd v. Shree Niwas Rammgopal, 2018 SCC OnLine Cal 4383.

[4] Indian Partnership Act, 1932, § 6, No. 9, Acts of Imperial Legislature, 1932 (India).

[5] KD Kamath and Company v. CIT, (1971) 2 SCC 873.

[6] Cox v. Hickman, (1860) 8 HLC 268.

[7] Id.

[8] UK Partnership Act 1860, 23 & 24 Vict. Sec. 2 (Eng.).

[9] Mollwo, March & Co v. Court of Wards, (1872) LR 4 PC 419.

[10] Id.

[11] Ex p Tennant, (1877) 6 Ch D 303.

[12] Helper Girdharbhai v. Saiyed Mohd Mirasaheb Kadri, (1987) 3 SCC 538.

[13] Hemchandra Dev v. Dhirendra Chandra Das, AIR 1960 Cal 691.

[14] AK Nithyanandham v. Saraswthi Velusamy, 2015 SCC OnLine Mad 7135.

[15] Raghunath Sahu v. Trinath Das, AIR 1985 Ori 8.

[16] Santiranjan Das Gupta v. Dasuram Murzamull, (1973) 3 SCC 463

[17] MP Davis v. Commr of Agricultural Income Tai AIR 1959 SC 719; Santiranjan Das Gupta v. Dasuram Murzamull, AIR 1973 SC 48.

[18] Prakash Boolu Kundar v. Shankar Aithu Poojari, 2006 SCC OnLine Bom 611.

[19] United India Insurance Co Ltd v. T Venkata Narsaiah, AIR 2003 NOC 119 (AP).

[20] Chimanram Motilal v. Jayantilal Chhaganlal, AIR 1939 Bom 410 (DB).

[21] Indian Partnership Act, 1932, § 13, No. 9, Acts of Imperial Legislature, 1932 (India).

[22] Hage Tera v. Hage Appo, 2014 SCC OnLine Gau 366.

[23] Singh Prithvi Singh v. Gyani Chand Kustoor Chand, AIR 1965 MP 100.

[24] Cox v. Hickman, (1860) 8 HLC 268.

[25] Taralakshmi Maneklal Thanawalla v. Shantilal Makanji Dave, 2015 SCC OnLine Bom 3967.

[26] Leela Shashikant Purandare v. Arvind Vishnu Govande, 2013 SCC OnLine Bom 1724.

[27] United India Insurance Co Ltd v. T Venkata Narsaiah, AIR 2003 NOC 119 (AP).

[28] Newstead v. Frost, [1980] 1 WLR 135.

[29] Norton Warburg Holdings Ltd v. Perera, (1982) 132 Ngp LJ 296.

[30] Prakash Boolu Kundar v. Shankar Aithu Poojari, 2006 SCC OnLine Bom 611.

[31] Sant Kumar v. Ashok Kumar, 2007 SCC OnLine MP 192

[32] Bhagwanti v. Kanshi Ram, 2011 SCC OnLine Del 5534.

[33] Vipin Dattaram Shetye v. Subray Shetty, 2018 SCC OnLine Bom 3565.

[34] Young Friends & Co v. Puri Investments, 2018 SCC OnLine Del 12334.

[35] Celina Coelho Pereira v. Ulhas Mahabaleshwar Kholakar, (2010) 1 SCC 217.

[36] CIT v. Sivakasi Match Exporting Co, AIR 1964 SC 1813.

[37] Stekel v. Ellice, 242.

[38] Steel v. Lester (1878) 3 CPD 121.

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