If a partner carries on a company of the same nature as the firm and competes with that of the firm, the partner must be accountable for and pay to the firm all the profits made in the business by the partner. The partnership firm will not be held liable for any losses caused in the business.

The ‘dissolution of a firm’ is a major term used for the ‘partnership firm’ precisely. The dissolution of the firm takes place for numerous reasons like dissolution by agreement, dissolution by legal notice, insolvency of the partners, or simply if the partnership firm is illegal in nature. In case of dissolution of the firm, the entire firm halts from the operation. This is quite different from the ‘dissolution of partnership’. 

Thus, in this context let us know more about the dissolution of the ‘firm’ and its difference from the ‘dissolution of partnership’.

What is the Dissolution of a Firm?

Dissolution of a firm refers to the dissolution of an existing partnership that owns and controls a firm or an organization. While numerous reasons can lead to the partnership’s dissolution in a firm, usually a concerned organization is also dissolved under these circumstances. However, this may not always be the case.

 While understanding dissolution meaning, students must note that according to the Partnership Act, 1932, “The dissolution of a partnership between all the partners of a firm is called the dissolution of the firm”. By definition, this distinguishes between the dissolution of a firm and that of a partnership. 

Only in the event of an existing agreement among a firm’s partners can it be reconstituted without any dissolution despite the partnership being dissolved. Consequently, a firm’s dissolution always involves the dissolution of a partnership, while it’s inverse may or may not be accurate and depends on existing agreements. 

Types of Dissolutions

While learning how is a firm dissolved, students must note these ways mentioned below:

Dissolution by Agreement:(SEC 40) A firm can be dissolved with an agreement among its existing partners, though it should meet the following criteria:

Every partner of a firm must consent to its dissolution.

There must be legally binding contracts among existing partners.

Mandatory Dissolution/complusory Dissolution:(SEC41) Circumstances under which a firm is dissolved compulsorily are as follows:

When one or more partners of a firm become insolvent, making them incompetent to enter any contract or agreement.

If it becomes unlawful for a specific partnership firm to continue its business and revenue generation. Notably, this is not the same as that of dissolution by court order. An example in this regard would be when a partnership firm has a foreign partner and war is declared by this firm’s country of origin on that of its foreign partner. Under such circumstances, this firm must be dissolved.

Emergency Dissolution Due to Contingencies(SEC42): A firm can be dissolved based on an existing contract among its partners only under these circumstances that are listed below:If a firm was established for a fixed tenure and that term has expiredIf a firm was established for a specific venture and that venture has been completedA partner’s demiseIf a partner of a firm becomes insolvent.

Dissolution by Notice of partnership at will(SEC43): If the partnership of a firm is at will, one of its partners can issue a notice for its dissolution. It must be issued in writing to all the existing partners and clearly state his/her intention towards dissolving a firm.

Dissolution by the Court:(SEC44) When one of the partners of a firm files a legal suit, a court of law can direct the dissolution of a firm. That can be done on any of the following grounds described below.

 if a partner has become of unsound mind; 

 if a partner has become permanently incapable of performing his duties as partner; 

 if a partner is guilty of conduct which is likely to affect prejudicially the carrying on ofbusiness, regarding being had to the nature of business;  

if a partner wilfully or persistently commits breach of agreements relating to

a) the management of the affairs of the firm; or 

b) the conduct of its business; or

 c) otherwise so conducts himself in matters relating to the business that it is not reasonably practicable for the other partners to carry on the business in partnershipwith him; 

 If a partner has in any way –

 a) transferred the whole of his interest in the firm to a third party; or 

b) has allowed his share to be charged; or

 c) has allowed it to be sold in the recovery of the arrears of land revenue; or 

D) of any dues recoverable as arrears of land revenue due by the partner;  

the business of the firm cannot be carried on save at a loss; or  on any other ground which renders it just and equitable that the firm should be dissolved.

EFFECT OF DISSOLUTION 

A) Continuing authority of partners

1) Authority of the partners continues even after dissolution so long as is necessary to wind upthe business. 

2) each partner has an equitable lien over the firm’s assets which he can apply to pay the debtsof the firm and to receive any amount due from partnership firm.

 B) Continuing liability of partners

 1) Liability of partners continues till the public notice of dissolution is given. 

2) Liability of partners continues for all things necessary for the winding up of the business. Thepartners may complete unfinished transactions 

C) Right to Return of Premium

a) To buy entry into an existing firm, a new partner sometimes has to pay a premium to theexisting partners in addition to any investment of capital. 

b) On dissolution, he is entitled to demand the return of a proportion of the premium if thepartnership was for a fixed term and was dissolved before the expiry of that term 

c) However, in the following 3 cases, partner will not get the premium return –

 1) Where the partnership was dissolved by agreement; or 

2) misconduct of the party seeking return of the premium; or 

3) death of a partner. 

D) Settlement of Accounts on Dissolution (order of payment)

a) Losses shall be paid first out of undistributed profits next out of capital, and lastly, ifnecessary, by the partners individually in the profit sharing ratio.

 b) The assets of the firm including the losses contributed by the partner as above shall beapplied in the following manner – 

1) in paying outside creditors; 

2) in repaying advances made by partners 

3) in repaying capital to partners; and 

4) if any amount is left then it shall be divided in PSR.