Partnership: meaning, nature and existence

1. The definition: section 4

Section 4 of the Indian Partnership Act, 1932 defines partnership as “the relation between persons who have agreed to share the profits of a business carried on by all or any of them acting for all.” Persons who have entered into partnership are individually called partners and collectively a firm, and the name under which the business is carried on is the firm name.

The Act came into force on 1 October 1932 and replaced Chapter XI of the Indian Contract Act, 1872 (sections 239 to 266). Section 3 keeps the unrepealed provisions of the Contract Act applicable to firms, so the general law of contract and agency fills the gaps.

2. Essentials of partnership

• An agreement. Partnership arises from contract. There must be at least two persons competent to contract. The Act fixes no upper limit, but section 464 of the Companies Act, 2013 read with Rule 10 of the Companies (Miscellaneous) Rules, 2014 bars an association of more than 50 persons from carrying on business for gain unless it is registered as a company.
• A business. Section 2(b) says business includes every trade, occupation and profession. A joint purchase of property to hold it, with no business, is not a partnership.
• Sharing of profits. The agreement must be to share profits. An agreement to share losses is not essential; a partner may by agreement be exempted from losses. A charitable association that does not divide profits is not a partnership.
• Mutual agency. The business must be carried on by all or by any of them acting for all. Each partner is both an agent of the others (binding them) and a principal (bound by their acts). This is what section 18 later makes explicit.

In K. D. Kamath & Co. v. C.I.T., Bangalore, 1971 INSC 281, (1971) 2 SCC 873, the Supreme Court restated these elements and held that a deed which gave one partner wide powers of management and control did not stop the relationship from being a partnership. What matters is that the business is carried on for the benefit of all and that the others remain bound by the acts of the managing partner.

3. Nature of a firm

In general law a firm is not a legal person distinct from its partners. The firm name is only a compendious description of the partners. In Commissioner of Income-tax v. A. W. Figgies & Co., 1953 INSC 55, AIR 1953 SC 455, the Court said that in the general law a firm is not an entity and that income-tax law treats it as a unit of assessment only for its own purposes. Following from this, a firm cannot itself be a partner in another firm, though its partners can join in their individual capacity: Dulichand Lakshminarayan v. Commissioner of Income-tax, 1956 INSC 11, AIR 1956 SC 354. The property of the firm belongs to the partners jointly: Malabar Fisheries Co. v. Commissioner of Income Tax, 1979 INSC 187, (1979) 4 SCC 766.

4. Partnership not created by status: section 5

Section 5 says the relation of partnership arises from contract and not from status. The section gives two examples: members of a Hindu undivided family carrying on a family business as such, and a Burmese Buddhist husband and wife carrying on business as such, are not partners. A coparcener becomes a member of the joint family business by birth, not by agreement.

5. Mode of determining existence: section 6

Section 6 tells the court to look at the real relation between the parties, as shown by all relevant facts taken together, not at the label they use. The Explanations add that sharing of profits or gross returns from property held jointly does not by itself make the owners partners, and that receiving a share of profits, or a payment contingent on profits, does not by itself make the receiver a partner. In particular, none of these persons is a partner merely because of a profit share:

• a lender to persons engaged in business;
• a servant or agent paid by a share of profits;
• the widow or child of a deceased partner receiving an annuity from profits;
• a previous owner or part owner of the business receiving profits as consideration for the sale of goodwill.

The rule comes from Cox v. Hickman (1860), House of Lords. A trader in difficulty assigned his business to trustees, who ran it and paid his creditors out of the profits. The creditors were held not to be partners: sharing of profits is evidence of partnership, but the real test is whether the business is carried on on their behalf, that is, whether there is agency. The Privy Council applied the same test in Mollwo, March & Co. v. Court of Wards (1872), where a lender with a share of profits and some control over the business was held not a partner.

6. Partnership compared

• Company. A company is a separate legal person created by registration, with perpetual succession and (usually) limited liability; members are not its agents and shares are freely transferable. A firm has no separate personality, partners have unlimited joint and several liability (section 25), each is an agent of the firm, and a partner cannot transfer his interest so as to make the transferee a partner (section 29).
• Co-ownership. Co-ownership may arise by operation of law (inheritance) and need not involve business; a co-owner can transfer his share without consent and is not an agent of the others. Partnership always rests on agreement and business.
• Hindu undivided family business. Membership arises by birth (section 5); the karta alone manages and binds the family; liability of the other coparceners is limited to their interest in the joint property; death of a member does not dissolve it; there is no limit on number; minors are members. A partnership rests on contract, each partner is an agent, liability is unlimited, and death of a partner dissolves the firm unless the contract says otherwise (section 42(c)).

7. Kinds of partnership by duration: sections 7 and 8

Where no provision is made by contract for the duration of the partnership or for its determination, it is a partnership at will (section 7). It can be dissolved by any partner giving written notice to all the others (section 43). A particular partnership is formed for particular adventures or undertakings (section 8), for example to build one building or to execute one contract; it ends on completion of the adventure (section 42(b)) unless the parties agree otherwise. A partnership for a fixed term ends on the expiry of the term (section 42(a)), and if the partners continue the business after that without a fresh agreement, section 17(b) presumes a partnership at will on the same terms.

8. Problem

A lends Rs 5 lakh to B's business on the term that he will receive 20 per cent of the annual profits instead of interest. The business fails and B's creditors sue A as a partner.

Issue. Whether a lender who receives a share of profits is a partner.

Law. Section 4 requires mutual agency; section 6 directs the court to the real relation, and its Explanation 2(a) says a lender receiving a share of profits is not for that reason a partner. Cox v. Hickman; Mollwo, March.

Application. A agreed only to advance money and take a return measured by profit. Nothing shows that B carried on the business on A's behalf or that A could bind B.

Conclusion. A is not a partner and is not liable to B's creditors. The answer changes if A took part in management, held himself out as a partner (section 28), or if the agreement shows the business was run for both.

How this is examined

As an essay: “Define partnership and explain its essential elements” or “Sharing of profits is not conclusive proof of partnership. Discuss.” Use section 4, the four essentials, section 6 with Cox v. Hickman, and end with section 5. As a short note: partnership and co-ownership, partnership and HUF, partnership at will. The lender with a profit share is the stock problem and is answered as above.