Individual partners in a business venture are referred to as “Partners,” and the association they form is known as a “Firm”. A Partnership Firm is formed when all the partners mutually agree to come together and establish a business with the same goal. The terms and conditions mutually agreed upon are documented in the Partnership agreement and are signed by all the partners of the firm. It is this agreement that forms the basis of the constitution of the Partnership Firm.
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According to the Indian Partnership Act of 1932, “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”. The act also mentions all the fundamental components of a partnership that are necessary for its formation, including the Partnership Deed or Agreement. By means of this blog, let us find out what these fundamental components are.
Definition of Partnership
The Indian Partnership Act 1932 governs partnership businesses in India. The act defines a Partnership under Section 4 as ” the relationship between people who have decided to split the earnings of a firm operated by all or any of them acting for all”.
According to the aforementioned definition, a partnership is made up of five components:
- A contract or deed
- Two or more individuals
- Mutual agreement on the contract
- Shared profits and liabilities
- Mutual Agency in Partnership
The 5 Essential Elements of a Partnership Firm
A partnership requires each of the five aforementioned components for its existence. We have discussed each of these components in detail below.
A contract between partners is the foundation of a partnership. It is the documented version of all the terms and conditions that the partners have agreed upon. It contains all the basic details of the partnership firm including its name, location, the names, rights, and obligations of the partners, their profit, loss, and capital sharing ratios.
A valid partnership agreement shall be signed by all partners in the presence of a notary. Additionally, the notary is also required to stamp the document under the seal of the government. The existence of a firm depends on the existence of the Partnership Agreement, in the absence of which the firm shall be declared null and void.
A partnership cannot have more than 20 partners
Since a partnership is the product of a contract, a minimum of two individuals are required to establish it. Although the Indian Partnership Act, 1932 makes no reference to the maximum number of partners in a partnership firm, a partnership with more than ten partners for banking business and more than 20 partners for any other business is deemed illegal.
A partnership firm cannot enter into a partnership agreement with another partnership firm or individual because it is not recognised as a legal person or distinct legal entity from that of its partners.
Mutual Agreement on the Contract
The parties’ agreement to run a firm is the third component for a partnership. Every trade, occupation, and profession can be qualified as “business” as long as it earns profits and revenues.Therefore, a non-profit business with the goal to carry out some philanthropic work cannot be qualified as a partnership firm.
Similarly, a group of people may agree to divide the income from a certain property or the bulk purchases of commodities among themselves. Such mutual arrangements cannot be termed as partnership and the people involved cannot be termed as partners, because neither a business is being operated nor revenues or profits are being earned.
This is the most crucial component of a partnership and ensures that the agreement to do business must have its goal as the distribution of profits among all its partners. As a result, there would be no partnership in cases where the business is run solely for charitable purposes and not for profit, or if only one person is entitled to the entire share of the company’s profits. Hence, it is essential that the partners share or distribute the profits among themselves in a Partnership Firm.
The partners are free to decide how they want to divide the profits among themselves. It is not necessary for partners to agree to split losses in order to form a partnership. It is also for one or more partners to decide the share of losses and liabilities that each of them would bear.
Additionally, the partnership agreement should explicitly define how the profits and losses will be divided. The requirements of the Partnership Act, 1932, which say that the profits/losses should be allocated equally among all partners, would apply only if the ratios are not exclusively mentioned in the partnership agreement.
However, it should be remembered that even while a partner is not permitted to partake in a company’s losses, his liability to third parties remains uncapped. A new type of partnership, known as Limited Liability Partnerships, has been developed in India in the event that the partners wish to restrict their liability to third parties. The partners’ responsibility to outsiders in a limited liability partnership is constrained.
Mutual Agency In a Partnership
According to the fifth essential component of the definition of a partnership, there must be a mutual agency between all of the partners or any one or more of them acting on their behalf. Each partner, therefore, shall be a principal and an agent for himself and all the other partners, meaning that the actions of each partner shall be binding on every other partner. The mutual agency component is crucial because it gives each partner the ability to conduct the business on behalf of other partners.
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