When there is any change in the composition of the partnership, it is called reconstitution of the partnership firm. The reconstitution takes place when
1. a new partner is admitted
2. a partner retires
3. a partner is expelled
4. a partner is declared insolvent
5. a partner dies
6. a partner transfers his interest to another person.
On the happening of the above events there is some change in the rights and liabilities of partners. Let us now study the relevant provisions of the Act which govern the above situations and know their effect on the rights and liabilities of partners.
Admission of a Partner
A person cannot be admitted as a partner in an existing firm without the consent of all the partners. This rule is however, subject to any provision to the contrary in the partnership agreement. For example, the partnership agreement between A, B and C provides that A could introduce into partnership any of his sons on attaining the age of majority. In such a situation, there is no need for the consent of B and C if A decides to admit his son (who has attained majority) as a partner.
An incoming partner is not liable for any debts of the firm, incurred before his admission as partner. His liability is limited only to those acts of the firm which are done after he becomes a partner. This general rule has two exceptions which are as follows.
a) By mutual agreement, he may undertake to share the liabilities for the past acts of the firm. But this does not entitle the creditors to proceed against the new partner for the recovery of old debts unless (i) the new firm has assumed the liabilities of the old firm, and (ii) the creditors have accepted the new firm as their debtor and discharged the old firm from its liability.
b) A minor admitted to the benefits of the firm who, on attaining majority decides to become a partner, shall be personally liable to third parties for all acts of the firm done since he was admitted to the benefits of partnership.
Retirement of a Partner
Any partner may retire from the firm in any of the following ways:
i) with the consent of all the other partners; or
ii) in accordance with an express agreement among the partners; or
iii) where the partnership is at will, by giving a notice in writing to all other partners of his intention to retire,
Liabilities: A retiring partner continues to remain liable for all the acts of the firm done before retirement or acts pending at the time of his retirement. He may, however be discharged from his liability towards the third parties by mutual agreement. Such agreement should be entered into between the three parties viz., all members of the reconstituted firm, the retiring partner and the concerned third party. Such an agreement may be express or implied.
Until public notice of the retirement of a partner is given, the retiring partner continues to be liable to third parties for any act done by any of the partners even after his retirement, which would have been an act of the firm if done before his retirement. However, the retired partner will not be liable to any third party who deals with the firm without knowing that he was not a partner. This would generally hold good in case of the retirement of a sleeping partner. (Public notice of retirement may be given either by retiring partner himself or by any other partner).
Rights: A retiring partner has the following two rights
1. He can carry on business competing with that of the firm and may advertise such business. But, in the absence of any agreement to the contrary, he cannot (i) use the name of the firm; (ii) represent himself as carrying on the business of the firm, or (iii) solicit the old customers. By mutual agreement, however, some restrictions can be imposed on the retiring partner. For example, he may be restrained from carrying on the competing business in a specified area for a specified period. This shall not be treated as restraint of trade.
2. If there is no final settlement of accounts between the retiring partner and the remaining partners and they continue to carry on business with the property of the firm, the retiring partner is entitled to claim (i) such share of the profits earned after his retirement which is attributable to the use of his share of the property of the firm, or (ii) interest at the rate of 6% p.a. on the amount of his share in the property. He can choose any of these two alternatives.
Expulsion of a Partner
Normally a partner cannot be expelled from partnership. However, the expulsion of a partner is possible if following three conditions are satisfied.
i) the power to expel a partner is available by an express agreement between the partners;
ii) the power has been exercised by a majority of the partners, and
iii) the power has been exercised in good faith and for the benefit of the firm.
A partner who is expelled from the firm is subject to the same right and liabilities as those of a retired partner.
Insolvency of a Partner
Where a partner of a firm is declared insolvent by a court of competent jurisdiction, he ceases to be a partner in the firm on the date on which the order of adjudication is made. It is not necessary that the firm is dissolved when a partner is declared insolvent. If, in accordance with the provisions of the partnership contract, the firm is not dissolved on the insolvency of a partner, the estate of the insolvent partner is not liable for any act of the firm, and the firm is not liable for any act of the insolvent, done after the date on which the order of adjudication is made.
Death of a Partner
Normally the firm is dissolved on the death of any of its partners. But, if the partnership contract provides that on the death of any partner the firm will not be dissolved, the remaining partners can continue with the firm’s business.
In that case, the estate of a deceased partner can be held liable only for those acts of the firm, which were done during the life time of the deceased partner. It shall not be liable for any act of the firm done after the date of his death. No public notice is required on the death of a partner.
Transfer of Partner’s Interest
A partner has the right to transfer his interest in the firm, fully or partially, to a third person. But, such a person (the transferee) is not treated as a partner. Neither he can take part in the conduct of the business of the firm not inspect its account books. He can simply claim his share in the profits of the firm.
If, however, the partner transfers his share in the firm on its dissolution or on ceasing to be a partner, the transferee will be entitled to claim the share of the transferring partner in the assets of the firm and for the purpose of ascertaining that share he can ask for on account as from the date of dissolution.
As a matter of fact, no partner can transfer his interest in the firm with the intention of making him a partner in the firm without the consent of all the other partners.
You should note that whenever change takes place in the constitution of the firm, the mutual rights and liabilities of the old partner in the reconstituted firm continue to remain the same as they were before the reconstitution took place. For example, A, B, C and D are partners who share profits in the ratio of 4:3:2:1. They admit a new partner E who is entitled to one-third share in the profits of the firm. In this situation, unless the partners decide otherwise. A, B, C and D shall continue to share the remaining two-third of the firm’s profits in the ratio of 4:3:2:1, the new profit-sharing ratio being 5:4:3:2:1.
