Essential features of formation of Partnership

What does Partnership Act say about Partnership?

Partnership comes into being only as a result of an agreement between the parties, general principles of law of contracts and agency are also relevant to partnership insofar as they are not inconsistent with the express provisions of Partnership Act 1932. Basic requirements of contract, i.e., legally enforceable agreement, mutual consent, competency of parties, free consent, lawful object, consideration, etc., do apply to partnership contract.

A partnership is simply an association of persons who have agreed to carry on a joint business and share the profits thereof.

Essential features for formation of partnership
Image: Essential features for formation of partnership

Essential features of a Partnership

The following features are essential to the formation of a partnership.

  1. Association of more than one person
  2. Result of an agreement
  3. Agreement to carry on some business
  4. Sharing of profits
  5. Mutual agency

1. Association of more than one person

It is one of the most basic elements of a valid partnership. To form a partnership there should be at least two persons. A partnership cannot survive if the number of partners gets reduced to one for whatever reasons — death, insolvency, lunacy, etc,. This is so because, one cannot be one’s own partner.

Ideal size of a Partnership:

Although the Partnership Act is silent over the maximum number of partners in a firm, there is a ceiling on the number of partners in a firm.

  • If a firm is engaged in financial services, the max number of partners should not exceed 10.
  • If a firm is engaged in some other business, the max number of partners may be up to 20.

If the number of partners exceeds this statutory limit, the partnership is rendered an illegal association.

In order to enter into a partnership, the persons must be competent to contract. It is, however, immaterial whether the persons so entered into a partnership contract are natural or artificial. A company may, if so authorized by its charter (Memorandum of Association), become a partner in a firm, as it is a person in legal terms though artificial one. There could be a partnership even between two or more companies. But a partnership firm not being a person in legal terms, cannot enter into partnership.

2. Result of an Agreement

Partnership is formed as a result of an agreement between two parties. It does not arise out of status or inheritance as in the case of Hindu Undivided Family (HUF). It even does not arise by operation of law as in the case of co-ownership or Joint Stock Company. Thus, creation of an agreement [whether express (written or oral) or implied] between two or more people is the very foundation of partnership. Besides, the contract must contain all essential elements of a valid contract.

3. Agreement to carry on some business

Another essential element of a partnership is that it is formed for the purpose of carrying on some (but lawful) business. An association or society formed primarily to carry on some charitable, religious, or social works cannot be regarded as partnership. Even a co-ownership does not amount to partnership.

The term ‘business‘ includes every trade, occupation, and profession. Thus, business is used in its widest sense as it does not refer merely to trade or industry but also includes occupations and professions such as chartered accountancy, legal practice, placement services, etc.

However, it is not necessary that the business should consist of a protracted (i.e., long lasting) and permanent undertaking. An agreement to carry on a business at a future time may not be considered as partnership until the actual time has arrived.

4. Sharing the profits

Sharing the profits of business amongst all the partners is the core of partnership. There will be no partnership where only one of the partners is entitled to the whole of the profits of the business. Sharing of loss is also an essential feature of partnership. However, all the partners may not concur to share losses. It depends on the terms of the agreement. Thus, one can become a partner on the understanding that he will not share the losses.

The partners are entitled to share equally in the profits earned and the loss sustained  in a business. The ratio in which the profits and losses will be shared need not be equal. Partners may mutually agree to share profits in any way they like among themselves.

Mere Sharing of profit alone is not partnership:

Merely sharing of profits does not necessarily entitle someone to be treated as partner. For instance, a manager, who besides his fixed salary gets a share in the profits of a firm’s business, can only claim to be an employee of the firm and not a partner.

Sharing of profits not a conclusive test The division of profits amongst the partners is an essential condition to sustain a partnership. But merely sharing profits does not automatically make someone a partner.

Although sharing of profits is a prima facie evidence of the existence of partnership, it is not the indisputable test of the same. It is also true that there can be no partnership without sharing of profits of the business, but sharing of profits alone does not constitute partnership. A person may have a share in the partnership profits, but still may not be a partner. The following examples may drive home the point.

Sharing of profits does not make one a partner

Example 1:  A and B who jointly own a house, let it out on a rent of INR 5,000 per month. They share the rental income equally. Yet  A  and  B  cannot be regarded as partners. They are simply co-owners of the property.

Example 2:  X and Y buy 100 bales of cotton, which they agree to sell for their joint account, each party sharing profits equally. Here  X  and  F  are partners in respect of such an account.

5. Mutual Agency

Mutual agency is the conclusive test of a partnership. Business of the firm may be carried on by all or any of the partners acting for all. This means that a partner is both an agent and a principal in a partnership firm. He is an agent because he can bind other partners, who are his principals, by his acts and he is again a principal, who in turn is bound by the acts of other partners. Thus, the partner who conducts the business of the firm not only acts for himself but for the other partners as well.

The true test, to determine whether a person is a partner or not, is to see interalia, whether the relationship of principal and agent exists between the parties. In fact existence of the element of agency is the foundation of partnership which is regarded as an extension of the general law of agency.

It is, however, not necessary that all partners should actively participate in business. The partners may authorize any one or more amongst themselves to manage the business of the firm. Under such an arrangement, the remaining partners will be bound by their acts, subject to the understanding that such acts relate to carrying on the business of the firm and have been carried out in the name of the firm. Also, participation in management by all partners is not compulsory.