Everything about a Partnership Firm

Partnership Firm

A partnership firm is a form of business organization that involves two or more persons who agree to share the profits and losses of a common business. A partnership firm is different from a sole proprietorship, where there is only one owner, and a corporation, where there are many owners who have limited liability. A partnership firm is based on the principle of mutual trust and cooperation among the partners.

Meaning and Definitions of Partnership Firm

The term “partnership” can have different meanings in different contexts. In a broad sense, a partnership can refer to any joint venture or collaboration between two or more parties, such as governments, nonprofits, businesses, or individuals. In a narrow sense, a partnership can refer to a specific type of business entity that is governed by the law of contracts.

According to the Oxford Dictionary for the Business World, "partner is a person who shares or takes part in activities of another person. Partnership is an association of two or more people formed for the purpose of carrying on a business".

According to Prof. L. H. Haney, "partnership is the relation existing between persons competent to make contracts, who agree to carry on a lawful business in common, with a view to private gains".

According to Clause 3(1) of the Nepal Partnership Act 2020 B.S., "partnership is 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".

This means that a partnership firm is a form of business organization that involves two or more persons who agree to share the profits and losses of a common business, and who can act on behalf of each other. A partnership firm is based on the principle of mutual trust and cooperation among the partners.

From these definitions, we can derive some common features of a partnership firm, which we will discuss in the next section.

Features of Partnership Firm

A partnership firm has the following characteristics:

1. Agreement: A partnership firm is based on a voluntary agreement between two or more persons who are competent to contract. The agreement can be oral or written, but it is advisable to have a written agreement, called a partnership deed, to avoid disputes and confusion.

2. Number of Partners: A partnership firm can have a minimum of two and a maximum of twenty partners, except in the case of banking, where the maximum limit is ten, and in the case of professional services, where there is no limit.

3. Business: A partnership firm must carry on a lawful business, which can be of any nature, such as trading, manufacturing, service, etc. The business must be carried on by all or any of the partners acting for all, which means that every partner is an agent as well as a principal of the firm.

4. Profit Sharing: A partnership firm must share the profits and losses of the business among the partners in an agreed ratio, or equally if there is no agreement. The partners are also entitled to interest on their capital and remuneration for their services, if provided in the agreement.

5. Liability: A partnership firm has unlimited liability, which means that the partners are jointly and severally liable for the debts and obligations of the firm. The personal assets of the partners can be used to pay off the creditors of the firm, if the firm’s assets are insufficient.

6. Mutual Agency: A partnership firm operates on the principle of mutual agency, which means that every partner can bind the firm and the other partners by his or her acts, as long as they are done in the ordinary course of business and in the name of the firm. Similarly, every partner can be bound by the acts of the other partners, unless he or she has expressly or impliedly dissented from them.

7. Legal Status: A partnership firm is not a separate legal entity, which means that it does not have a distinct identity from its partners. The firm cannot own property, sue or be sued, or enter into contracts in its own name. The partners are the real owners and representatives of the firm.

Reasons for Starting a Partnership Firm (Advantages/ Merits)

A partnership firm has some advantages over other forms of business organization, such as:

1. Ease of Formation: A partnership firm is easy to form, as it does not require any legal formalities or registration, except in some cases where the registration is mandatory or beneficial. The partners can start the business by entering into a simple agreement, either oral or written.

2. More Capital: A partnership firm can raise more capital than a sole proprietorship, as there are more partners who can contribute their funds and assets to the business. The partners can also borrow money from banks and other sources on the basis of their joint creditworthiness.

3. More Skills: A partnership firm can benefit from the diverse skills, knowledge, and experience of the partners, who can manage different aspects of the business, such as production, marketing, finance, etc. The partners can also consult and advise each other on important matters and decisions.

4. Flexibility: A partnership firm is flexible, as it can adapt to the changing needs and circumstances of the business. The partners can modify the terms and conditions of the agreement, such as the profit sharing ratio, the capital contribution, the management responsibilities, etc., by mutual consent.

5. Tax Benefits: A partnership firm enjoys some tax benefits, as it is not taxed as a separate entity. The profits of the firm are taxed only in the hands of the partners, according to their individual income tax rates. The partners can also claim deductions for interest on capital, remuneration, and other expenses, if provided in the agreement.

Challenges of a Partnership Firm (Disadvantages/ Demerits)

A partnership firm also has some disadvantages or limitations, such as:

1. Unlimited Liability: A partnership firm has unlimited liability, which means that the partners are personally liable for the debts and obligations of the firm, even if they are incurred by the other partners without their knowledge or consent. The personal assets of the partners can be attached by the creditors of the firm, if the firm’s assets are insufficient.

2. Lack of Continuity: A partnership firm lacks continuity, as it is dissolved by the death, insolvency, retirement, or insanity of any partner, unless there is a provision in the agreement for the continuation of the firm. The firm is also dissolved by the mutual agreement of the partners, or by the expiry of the term of the partnership, if any.

3. Lack of Harmony: A partnership firm may suffer from a lack of harmony, as there may be conflicts and disputes among the partners over various issues, such as the profit-sharing ratio, the capital contribution, the management responsibilities, the admission or expulsion of a partner, etc. The lack of harmony may affect the efficiency and performance of the business.

4. Lack of Public Confidence: A partnership firm may lack public confidence, as it is not subject to any legal regulations or disclosures, except in some cases where the registration is mandatory or beneficial. The firm does not have to publish its accounts or reports, and the partners can keep the affairs of the business secret. This may create doubts and suspicions in the minds of the customers, suppliers, creditors, and other stakeholders.

5. Limited Resources: A partnership firm has limited resources, as it can have a maximum of twenty partners, except in the case of banking, where the maximum limit is ten, and in the case of professional services, where there is no limit. The firm may not be able to raise enough capital and funds to expand and diversify its business activities. The firm may also face difficulties in attracting and retaining qualified and skilled personnel, as it cannot offer them the benefits of ownership or limited liability.

Types of Partners

Partners are the owners of a partnership firm, who contribute capital, skills, and expertise to the business. Partners can be classified into different types, based on their role, responsibility, and liability in the firm. Some of the common types of partners are:

a. Active Partner: An active partner is also known as a managing partner or an ostensible partner. He or she takes an active part in the management and operation of the business, and represents the firm in dealing with third parties. An active partner has unlimited liability for the debts and obligations of the firm, and can bind the firm and the other partners by his or her acts, as long as they are done in the ordinary course of business and in the name of the firm. An active partner is entitled to a share in the profits and losses of the firm, and may also receive a salary or commission for his or her services.

b. Sleeping/ Passive/ Dormant Partner: A sleeping partner is also known as a dormant partner or a silent partner. He or she does not take part in the management and operation of the business, and does not deal with third parties on behalf of the firm. A sleeping partner has unlimited liability for the debts and obligations of the firm, but cannot bind the firm and the other partners by his or her acts, unless he or she has expressly or impliedly authorized them. A sleeping partner is entitled to a share in the profits and losses of the firm, but does not receive any salary or commission for his or her services.

c. Nominal Partner: A nominal partner is also known as a partner by estoppel or a partner in name only. He or she does not have any real interest or stake in the business, and does not contribute any capital, skills, or expertise to the firm. A nominal partner only lends his or her name and reputation to the firm, for the benefit of the other partners. A nominal partner has unlimited liability for the debts and obligations of the firm, and can bind the firm and the other partners by his or her acts, as long as they are done with his or her consent or knowledge. A nominal partner is not entitled to any share in the profits and losses of the firm, and does not receive any salary or commission for his or her services.

d. Limited Partner: A limited partner is a partner who has limited liability for the debts and obligations of the firm, up to the extent of his or her capital contribution. A limited partner does not take part in the management and operation of the business, and does not deal with third parties on behalf of the firm. A limited partner cannot bind the firm and the other partners by his or her acts, unless he or she has expressly or impliedly authorized them. A limited partner is entitled to a share in the profits and losses of the firm, but does not receive any salary or commission for his or her services. A limited partner is usually found in a limited partnership, which is a type of partnership that we will discuss later.

e. Secret Partner: A secret partner is a partner who takes part in the management and operation of the business, but does not disclose his or her identity or partnership to the third parties. A secret partner has unlimited liability for the debts and obligations of the firm, and can bind the firm and the other partners by his or her acts, as long as they are done in the ordinary course of business and in the name of the firm. A secret partner is entitled to a share in the profits and losses of the firm, and may also receive a salary or commission for his or her services.

f. Partner by Holding Out: A partner by holding out is a person who is not a partner of the firm, but who represents himself or herself, or allows himself or herself to be represented, as a partner of the firm, to the third parties. A partner by holding out has unlimited liability for the debts and obligations of the firm, and can bind the firm and the other partners by his or her acts, as long as they are done with his or her consent or knowledge. A partner by holding out is not entitled to any share in the profits and losses of the firm, and does not receive any salary or commission for his or her services.

g. Sub-Partner: A sub-partner is a person who enters into a partnership with one or more of the partners of the firm, without the consent or knowledge of the other partners of the firm. A sub-partner does not have any direct relation with the firm, and does not deal with third parties on behalf of the firm. A sub-partner has no liability for the debts and obligations of the firm, and cannot bind the firm and the other partners by his or her acts. A sub-partner is entitled to a share in the profits and losses of the sub-partnership, but not of the main partnership.

h. Minor Partner: A minor partner is a person who is below the age of majority, and who is admitted to the benefits of the partnership, with the consent of all the partners of the firm. A minor partner does not have the capacity to contract, and does not take part in the management and operation of the business. A minor partner has limited liability for the debts and obligations of the firm, up to the extent of his or her share in the profits. A minor partner is entitled to a share in the profits and losses of the firm, but does not receive any salary or commission for his or her services. A minor partner can become a full-fledged partner on attaining the age of majority, by giving a public notice of his or her intention to do so.

Types of Partnerships

Partnerships are also classified into different types, based on the nature, duration, and liability of the partnership. Some of the common types of partnerships are:

A. General Partnership: 

A general partnership is a type of partnership that involves two or more persons who agree to share the profits and losses of a common business, and who have unlimited liability for the debts and obligations of the firm. A general partnership can be further divided into two sub-types: partnership at will and particular partnership. A partnership at will is a partnership that has no fixed duration or purpose, and can be dissolved at any time by any partner, by giving a notice of his or her intention to do so. A particular partnership is a partnership that is formed for a specific duration or purpose, and can be dissolved only after the expiry of the duration or the completion of the purpose, or by mutual consent of all the partners.

B. Limited Partnership: 

A limited partnership is a type of partnership that involves two or more persons who agree to share the profits and losses of a common business, but who have different levels of liability for the debts and obligations of the firm. A limited partnership must have at least one general partner, who has unlimited liability for the debts and obligations of the firm, and at least one limited partner, who has limited liability for the debts and obligations of the firm, up to the extent of his or her capital contribution. A limited partnership is usually formed for a specific duration or purpose, and can be dissolved only after the expiry of the duration or the completion of the purpose, or by mutual consent of all the partners.

C. Limited Liability Partnership: 

A limited liability partnership is a type of partnership that involves two or more persons who agree to share the profits and losses of a common business, and who have limited liability for the debts and obligations of the firm. A limited liability partnership is a hybrid form of business organization, that combines the features of a partnership and a corporation. A limited liability partnership is registered under the law, and has a separate legal identity from its partners. A limited liability partnership can sue and be sued, own property, and enter into contracts in its own name. A limited liability partnership is usually formed for a professional service, such as accounting, law, or consulting, and can be dissolved only by following the legal procedure.

Meaning and Definition of Partnership Deed

A partnership deed is a written document that contains the terms and conditions of the partnership between the partners. A partnership deed is also known as a partnership agreement or a partnership contract. A partnership deed is not mandatory by law, but it is advisable to have one, to avoid disputes and confusion among the partners. 

A partnership deed can be registered or unregistered, depending on the requirements of the law and the partners. A registered partnership deed has more legal validity and enforceability than an unregistered one.

According to Corpseed, “partnership deed is a written legal document that contains an agreement made between two individuals who have the intention of doing business with each other and share profits and losses. It is also called a partnership agreement”.

According to Prof. L. H. Haney, "a partnership deed is a written agreement between the partners, containing the terms and conditions of the partnership, such as the nature and scope of the business, the rights and duties of the partners, the mode of dissolution of the partnership, etc.".

Main Contents of a Partnership Deed

Although there is no specific format prescribed for drafting a partnership deed, a typical deed contains the below mentioned clauses:

1. The name of the firm and the names and addresses of the partners who compose it.
2. The nature and scope of the business and the place where it would be carried on.
3. The date of commencement and duration of the partnership.
4. The amount of capital contributed by each partner and the ratio of sharing profits and losses.
5. The interest to be allowed on capital and charged on drawings.
6. The rights and duties of each partner and the management responsibilities.
7. The salary, commission, or remuneration payable to any partner.
8. The method of valuation and treatment of goodwill.
9. The accounting method and audit procedure to be followed.
10. The mode of settlement of disputes among the partners or with third parties.
11. The procedure for admission, retirement, expulsion, or death of a partner.
12. The mode of dissolution of the firm and the distribution of assets and liabilities.

Rights of Partners

Partners can exercise the following rights under the Act unless the partnership deed states otherwise:

1. Right to participate in business: Each partner has an equal right to take part in the conduct of the business, unless otherwise agreed upon. Partners can also waive this right by mutual consent.

2. Right to be consulted: Each partner has a right to be consulted and to express his or her opinion on matters affecting the business. The decisions are usually made by a majority of the partners, except in fundamental matters, which require the consent of all the partners.

3. Right to access and inspect books: Each partner has a right to have access to and inspect any of the books and records of the firm. This right can be exercised either by the partner himself or herself or by his or her authorized agent.

4. Right to indemnity: Each partner has a right to be indemnified by the firm for any expenses incurred or losses suffered by him or her in the ordinary and proper conduct of the business, or for any act done in an emergency to protect the firm from loss.

5. Right to share profits: Each partner has a right to share the profits of the firm in an agreed ratio, or equally if there is no agreement. The partners are also liable to share the losses of the firm in the same ratio.

6. Right to interest on capital: Each partner has a right to receive interest on his or her capital at a rate agreed upon, or at 6% per annum if there is no agreement. However, the interest is payable only out of profits.

7. Right to interest on advances: Each partner has a right to receive interest on any advances made by him or her to the firm, in addition to his or her capital, at a rate agreed upon, or at 6% per annum if there is no agreement. The interest is payable irrespective of profits or losses.

8. Right to the use of the partnership property: Each partner has a right to use the property of the firm for the purpose of the business, and not for any other purpose, without the consent of the other partners.

9. Right to act in an emergency: Each partner has a right to act in an emergency to protect the firm from loss, and to do all such acts as are necessary for that purpose. Such acts bind the firm and the other partners.

10. Right to retire: Each partner has a right to retire from the firm by giving a notice of his or her intention to do so, if the partnership is at will. If the partnership is for a fixed term or a specific purpose, a partner can retire only with the consent of all the other partners, or in accordance with the partnership deed.

11. Right not to be expelled: Each partner has a right not to be expelled from the firm by any majority of the partners, unless there is a provision in the partnership deed for expulsion of a partner on certain grounds.

12. Right to carry on competing business: Each partner has a right to carry on any business other than that of the firm, after ceasing to be a partner, unless there is a contract to the contrary. However, a partner cannot use the name or goodwill of the firm, or solicit the customers of the firm, for his or her own business.

Duties of Partners

Partners have the following duties under the Act, which cannot be altered by any contract:

1. Duty to act in good faith: Each partner has a duty to act in good faith and for the greatest common advantage of the firm and the other partners. A partner cannot make any secret profits or engage in any competing business at the expense of the firm.

2. Duty not to compete: Each partner has a duty not to carry on any business of the same nature as and competing with that of the firm, without the consent of the other partners. If a partner does so, he or she has to account for and pay to the firm all the profits made by him or her in that business.

3. Duty to be diligent: Each partner has a duty to be diligent and to attend diligently to his or her duties in the conduct of the business. A partner cannot claim any remuneration for his or her services, unless there is a contract to the contrary.

4. Duty to indemnify for fraud: Each partner has a duty to indemnify the firm and the other partners for any loss caused to them by his or her fraud or misconduct in the conduct of the business.

5. Duty to render true accounts: Each partner has a duty to render true accounts and full information of all things affecting the firm to any partner or his or her legal representative.

6. Duty to properly use the property of the firm: Each partner has a duty to use the property of the firm exclusively for the purpose of the business, and not for his or her own benefit or any other purpose, without the consent of the other partners.

7. Duty not to earn personal profits: Each partner has a duty not to earn any personal profits from any transaction of the firm, or from the use of the property, name, or goodwill of the firm, without the consent of the other partners. If a partner does so, he or she has to account for and pay to the firm all such profits.

8. Duty to account for personal profits: Each partner has a duty to account for and pay to the firm all the profits made by him or her from any transaction of the firm, or from the use of the property, name, or goodwill of the firm, without the consent of the other partners. This duty continues even after the dissolution of the firm, until the affairs of the firm are completely wound up.

Requirements for registering a Partnership Firm in Nepal

According to the Partnership Act, 2020 (1964), a partnership firm is a business entity that is formed by two or more persons who agree to share the profits and losses of a common business, and who have registered their firm in the record of the Government of Nepal. The registration of a partnership firm is not compulsory, but it is advised to do so, to avoid disputes and confusion among the partners and third parties.

To register a partnership firm in Nepal, the following documents are required:

1. The name of the partnership firm.
2. The address of the partnership firm and rent agreement letter (if applicable).
3. The objectives, functions, and the particulars of goods or commodities to be transacted by the partnership firm.
4. The name and address of each partner and the name of their parents and grandparents.
5. The partnership agreement letter, which specifies the terms and conditions of the partnership, such as the capital contribution, profit and loss sharing ratio, rights and duties of each partner, management responsibilities, etc.
6. The self-declaration letter stating the intention to register the partnership firm.
7. The bank statement with enough balance to cover the capital of the partnership firm.

Procedures of Registration of Partnership Firm in Nepal

The registration of a partnership firm in Nepal can be done online or offline, depending on the nature and scope of the business. The registration can be done at the following departments:

• The Department of Commerce, in the case of a commerce-related firm (such as trading, sales and purchase, shops, import, and export firms, etc.).
• The Department of Cottage and Rural Industry, in the case of a cottage and rural industry (such as handicrafts, agro-products, etc.).
• The Department of Industry, for any other types of industries (such as manufacturing, services, etc.).

The procedures of registration of a partnership firm in Nepal are as follows:

a. Filling up the form: Fill up the prescribed application form for registration of partnership firm, which can be obtained from the respective department or downloaded from their website.

b. Application Submission: Submit the application form along with the required documents and the prescribed fees to the concerned department. The fees may vary depending on the type and size of the business.

c. Getting Registration Certificate: Obtain the registration certificate from the department after the verification and approval of the application and documents. The registration certificate is the proof of the existence and validity of the partnership firm.

Procedures of Renewal of Partnership Firm in Nepal

The renewal of a partnership firm in Nepal is also done at the same department where the registration was done. The renewal is required to be done every year, within the last day of the Nepali month of Ashadh (mid-July). The procedures of renewal of a partnership firm in Nepal are as follows:

• Fill up the prescribed application form for renewal of partnership firm, which can be obtained from the respective department or downloaded from their website.
• Submit the application form along with the renewal fee and the updated documents (such as the partnership agreement, bank statement, etc.) to the concerned department. The renewal fee may vary depending on the type and size of the business.
• Obtain the renewal certificate from the department after the verification and approval of the application and documents. The renewal certificate is the proof of the continuation and validity of the partnership firm.

Effects of Non-Registration and Non-Renewal of Partnership Firm in Nepal

The non-registration and non-renewal of a partnership firm in Nepal can have some adverse effects on the firm and the partners, such as:

1. The firm and the partners may lose the legal recognition and protection under the law. They may not be able to sue or be sued in their name, and may face limitations in seeking legal remedies.
2. The firm and the partners may miss out on some benefits and exemptions available to registered and renewed firms, such as tax incentives, credit facilities, business expansion opportunities, etc.
3. The firm and the partners may encounter tax-related issues, such as penalties, fines, audits, etc., for not complying with the tax laws and regulations.
4. The firm and the partners may face difficulties in dealing with third parties, such as customers, suppliers, creditors, etc., as they may lack the public visibility and credibility of a registered and renewed firm.

Modes of Dissolution of Partnership Firm in Nepal

The dissolution of a partnership firm in Nepal means the termination of the partnership relationship among all the partners and the winding up of the business of the firm. According to Section 37 of the Nepal Partnership Act 2020 B.S., a partnership firm can be dissolved by the following modes:

1. Dissolution by agreement: A partnership firm can be dissolved by the mutual agreement of all the partners, if the partnership deed provides for such a mode of dissolution, or if the partners consent to dissolve the firm at any time. The partners can decide the terms and conditions of the dissolution, such as the settlement of accounts, the distribution of assets and liabilities, the discharge of debts, etc. This mode of dissolution is simple, flexible, and convenient, as it does not involve any legal formalities or intervention of third parties.

2. Dissolution by written notice: A partnership firm can be dissolved by a written notice given by any partner to the other partners, if the partnership is at will, i.e., if the partnership has no fixed duration or purpose, or if the partnership deed does not provide for any mode of dissolution. The notice must state the intention of the partner to dissolve the firm, and the date of dissolution. The notice must be served to all the partners personally, or by registered post, or by publication in a newspaper. This mode of dissolution is quick, easy, and unilateral, as it does not require the consent of the other partners, but it may cause disputes and conflicts among the partners, as it may be unfair and arbitrary.

3. Dissolution at any time: A partnership firm can be dissolved at any time by any partner, if the partnership is for a fixed term or a specific purpose, and if the partnership deed provides for such a mode of dissolution. The partner who wants to dissolve the firm must give a reasonable notice to the other partners, and must pay compensation for any loss or damage caused to the firm or the other partners by his or her act of dissolution. This mode of dissolution is flexible, as it allows the partner to exit the firm before the expiry of the term or the completion of the purpose, but it may also create instability and uncertainty in the firm, as it may disrupt the continuity and performance of the business.

4. Dissolution after expiry of time: A partnership firm can be dissolved after the expiry of the term for which it was formed, if the partnership is for a fixed term, and if the partnership deed does not provide for any mode of dissolution. The term of the partnership can be specified in the partnership deed, or can be inferred from the nature and scope of the business. This mode of dissolution is automatic, as it does not require any notice or consent of the partners, but it may also be inconvenient, as it may terminate the firm when the business is still profitable and viable.

5. Dissolution at once: A partnership firm can be dissolved at once by any partner, if the partnership is for a specific purpose, and if the partnership deed does not provide for any mode of dissolution. The purpose of the partnership can be specified in the partnership deed, or can be inferred from the nature and scope of the business. This mode of dissolution is immediate, as it does not require any notice or consent of the partners, but it may also be premature, as it may end the firm before the achievement of the purpose.

6. Dissolution by the concerned department: A partnership firm can be dissolved by the concerned department, i.e., the Department of Commerce, the Department of Cottage and Rural Industry, or the Department of Industry, depending on the nature of the business, if the partnership firm violates any provisions of the law, or if the partnership firm is found to be involved in any illegal or immoral activities. The concerned department can issue a notice to the partnership firm, stating the reasons and grounds for the dissolution, and giving a reasonable time for the firm to show cause why it should not be dissolved. If the partnership firm fails to show cause, or if the cause shown is not satisfactory, the concerned department can issue an order to dissolve the firm, and publish the order in the Nepal Gazette. This mode of dissolution is compulsory, as it is imposed by the authority, but it may also be harsh, as it may deprive the partners of their rights and interests in the firm.

Conclusion

A partnership firm is a form of business organization that involves two or more persons who agree to share the profits and losses of a common business. A partnership firm has some advantages and disadvantages over other forms of business organization, such as sole proprietorship and corporation. The choice of a partnership firm depends on the needs, goals, budget, and preferences of the prospective partners. It is advisable to have a written agreement, called a partnership deed, to avoid disputes and confusion among the partners.