The manner for settling partnership accounts after dissolution of the firm, is usually provided in the partnership contract itself. If, however, the partnership contract is silent on the matter, the accounts of the dissolved firm shall be settled according to the rules given is sections 48, 49 and 55 of the Act. These rules are as follows:
1. Sharing of deficiency: According to Section 48(a) the losses including deficiencies of capital, shall be paid first out of profits next out of capital, and lastly, if necessary, by the partners individually in the proportion in which they were entitled to share profits.
This implies that if the assets of the firm are insufficient to discharge the liabilities of the firm, the partners shall bear the deficiency in their profit-sharing ratio and pay them out of their private assets, if necessary.
Example:A, B, C and D are partners in a business sharing profits and losses equally. A die and the firm are dissolved. On the date of dissolution, it was found that the capitals of A and B were Rs. 20,000 each and that of C and D Rs. 10,000 and Rs. 5,000 respectively. The outside liabilities stood at Rs. 61,000 and the total value of assets at Rs. 41,000. Thus, the deficiency works out at Rs. 20,000 (61,000 - 41,000). This would be equally shared by B, C and D and the legal heir of A i.e., Rs. 5,000 each.
2. Application of assets: The assets of the firm including any sums paid by the partners to make up deficiencies of capital shall be applied in the following order:
i) in paying off the debts of third parties,
ii) in paying to each partner ratably what is due to him from the firm for advances as distinguished from capital,
iii) in paying to each partner ratably what is due to him on account of capital, and
iv) the surplus, if any shall be divided among the partners in the proportion in which they were entitled to share profits. [Section 48(b)]
Let us understand this with the help of an example. A, B and C were partners in a firm sharing profits and losses equally. The accounts show that, on the date of dissolution, partners’ capital was A-Rs. 20,000, B-Rs. 10,000 and C-Rs. 2,000. A had advanced Rs. 2,000 as loan to the firm, the outside liabilities were Rs. 13,000. The asset could realize Rs. 50,000. This amount shall be utilized first to pay Rs. 13,000 of outside liability, next Rs, 2,000 to A for repayment of his loan then Rs. 32,000 to A, B and C for their capital (Rs. 20,000 to A. Rs. 10,000 to B and Rs. 2,000 to C), and the remaining amount of Rs. 3,000 shall be shared equally (profit sharing ratio) by A, B and C.
Suppose the assets realised Rs. 42,500 only resulting in a loss of Rs. 4,500 (Rs. 47,000 - Rs. 42,500). This loss shall be shared by A, B and C equally reducing their capital balances to Rs. 18,500, Rs. 8,500 and Rs. 500 respectively. So, the amount of Rs. 42,500 shall be used as follows:
i) Rs. 13,000 to pay outside liabilities
ii) Rs. 2,000 to pay A’s loan, and
iii) Rs. 27,500 to pay the capital balances of A, B and C.
3. Payment of firm’s debts and separate debts of partners: You know that the partners are jointly and severally liable to pay the debts of the firm. This means that even the private assets of the partners can be utilised for payment of firm’s debts, if necessary. Not only that, the third party has the right to realize the whole amount from any partner. This however is subject to the provision of Section 49 which states that the private assets of any partner shall be applied first, to pay his private debts, and then, if there is any surplus, it can be applied to pay the debts of the firm, if necessary. Thus, partner’s private assets can be used for payment of firm’s debts only after his private liabilities have been paid off and that too if firm’s assets are insufficient to pay firm’s debts.
It should be noted that firm’s assets are also used first for payment of firm’s liabilities and then the surplus, if any, can be used for payment of the private debts of a partner only to the extent of his share in the property of the firm.
4. Loss arising from insolvency of a partner: If, on distribution of the final amount of loss on dissolution, a partner’s capital account shows some deficiency, he shall bring in the amount of deficiency in cash so that the other partners can be paid their amounts of capital. But, if the partner whose capital account shows deficiency is insolvent, he may not be able to bring in the necessary amount (fully or in part) resulting in additional loss to other partners. In such a situation, the question arises about the ratio in which the other partners are to share such loss. This is done in the light of a prominent English case of Garner v. Murray which states that the loss arising from the deficiency of an insolvent partner’s capital should be borne by the solvent partners in proportion to their respective capitals as they stood on the date of dissolution. To continue with the same example of A, B and C who share profits equally, if the assets realize Rs. 35,000 only this would result in a loss of Rs. 12,000 (Rs. 47,000 - Rs. 35,000). When this amount of loss is shared by A, B and C their capital balances will reduce to: A - Rs. 16,000, B - Rs. 6,000 and C - Rs. (-) 2,000. After paying Rs. 13,000 for outside debts and Rs. 2,000 for A’s loan, we are left with Rs. 20,000 as against Rs. 22,000 to be paid to A - Rs. 16,000 and B - Rs. 6,000. There is no problem if C can bring in Rs. 2,000 due from him. But if he becomes insolvent and only Rs. 500 can be realised from him, then there will be a deficiency of Rs. 1,500 which will be shared by A and B in the ratio of their capitals i.e., 2:1 (not equally as per their profit-sharing ratio). Thus, their capitals will stand reduced to A - Rs.15,000 (Rs. 16,000 - Rs. 1,000) and B - Rs. 5,500 (Rs. 6,000 - Rs. 500) which can now be paid to them with the help of the amount (Rs. 20,000) left after paying outside debts and A’s loan plus Rs. 500 realised from C’s estate.
5. Sale of goodwill: According to Section 55, in settling the accounts of a firm after dissolution, goodwill shall, subject to contract between the partners, be included in the assets, and it may be sold either separately or along with other property of the firm.
When, after dissolution of the firm, the goodwill of the firm has been sold, a partner may (i) carry on a business competing with that of the buyer i.e., the partner of the dissolved firm can carry on the same business as that of the dissolved firm, and (ii) advertise such business.
But, subject to agreement between him and the buyer, he may not
a) use the firm’s name.
b) represent himself as carrying on the business of the old firm, or
c) solicit the business from the customers of dissolved firm.
However, any partner may enter into an agreement with the buyer of goodwill that such partner will not carry on any business similar to that of the dissolved firm within a specified period or within the specified local limits. Such agreement shall be valid if restrictions imposed are reasonable as it would not be barred by Section 27 of the Indian Contract Act, which deals with the agreements in restraint of trade.
