Dissolution of a Partnership firm and Settlement of accounts on dissolution

The dissolution of a partnership firm is said to be dissolved when the relationship between the partners is terminated. In case of dissolution, the firm ceases to exist. The process of dissolution includes disposing of the assets and the liabilities are paid off. The firm discontinues all of its activities and no partner has any relation with the other partners. The dissolution of a partnership firm is different from the dissolution of the partnership. In case of dissolution of a partnership, the partnership agreement among the partners is terminated due to the following reasons: 

• Admission of a new partner 
• Insolvency, retirement or death of a partner 
• Change in existing profit ratio 
• On completion of a specific venture for which the partnership was formed. 
• On the expiry of the period for which partnership was formed. 

The other partners can continue the business by entering into a new agreement. A partnership can be dissolved without dissolving the firm. The dissolution of partnership means a change in partnership whereas the dissolution of a partnership firm means discontinuance of a firm’s business. 

According to Sec 39 of The Partnership Act, 1932 the dissolution of the partnership between all the partners of a firm is called the ‘dissolution of the firm‘.  

After this, A partnership firm cannot do any kind of business activity with anybody. It can only dispose of the assets of the firm to realize the amount, pay the liabilities of the firm, and discharge the claims of the partners. 

The dissolution of the partnership firm can take place in the following ways: 

1. Dissolution by Agreement: A partnership firm may be dissolved if all the partners agree for the dissolution or in accordance with the terms of the agreement.

2. Dissolution by notice: When a partnership is formed at will, the dissolution of the firm may take place if any of the partners gives a notice in writing to the other partners indicating his intention to dissolve the firm. 

3. Contingent Dissolution: In this case, a partnership may be dissolved on the happening of any of the following contingencies:

• On the expiry of the term, if the partnership is formed for a fixed term. 

• On the completion of a specific venture for which the partnership was formed. 
• On the death of a partner 
• On the insolvency of a partner  

4. Compulsory Dissolution: The compulsory dissolution of the firm takes place in the following cases:

• When all the partners or all but one partner are declared insolvent 

• When the business of the firm becomes illegal due to some reason. 
• When the business of the firm becomes unlawful due to the happening of an event. 

5. Dissolution by Court: The dissolution of a partnership firm may be ordered by the court on the following grounds:

• When a partner becomes insane 
• When a partner becomes permanently incapable of performing his duties as a partner. 

• When a partner is guilty of misconduct which is more likely to affects the reputation and business of the firm. 
• When a partner continuously commits a breach of the partnership agreement. 
• When a partner transfers the whole of his interest or share in the firm to a third party. 
• When the business of the firm cannot be carried on except at a loss. 
• When the court’s opinion regarding the dissolution of the firm to be just and equitable on any ground. 

Settlement of accounts on dissolution 

According to Sec. 48 of The Indian Partnership Act,1932, the following procedure is to be followed for the settlement of accounts between partners after the dissolution of the firm: 

1. Losses including deficiencies of capital shall be first paid out from the profits, next from the capital, and if necessary, by the personal contribution of partners in their profit-sharing ratio. 

2. The assets of the firm, including any sum contributed by the partners to make up deficiencies of capital, will be applied in the following manner:

• Payment of the debts of the firm to the third parties 
• Payment of advances and loans given by the partners 
• Payment of capital contributed by the partners 
• The surplus, if any, will be divided among the partners in their profit-sharing ratio.