Partnership Doctrine: The Intrinsic Interplay between Facts and Law

1. Introduction

In India, Partnership, which provides for the right of association, has been guaranteed under  Article 19(1)(c) of the Indian constitution (the freedom to form or associate with unions). The rights and obligations of a partnership firm do not have a distinct legal existence and are guarded by the Indian Partnership Act.[1]

The Indian Partnership Act, despite its robust nature, remains silent on various aspects pertaining to the establishment of a partnership and in turn requires a manual effort by analysing the factual matrix. This article is an endeavour at delving into some of the locus classicus cases where the courts due to the shortcomings of the statutes, were compelled to prioritize facts, sidestepping the common notions, while pronouncing the verdict.

2. Essential Ingredients of a Partnership

In sync with the Indian Partnership Act, S. 4, the Supreme Court, in KD Kamath v CIT has held that two essential conditions need to be satisfied for the creation of a partnership: [2]

  1. An agreement to share the profits or losses of the business.
  2. The business must be carried out by all, or by an agent on behalf of all of them.

Further, there are three essential elements, guarding the concept of ‘Partnership’ which include:[3]

There must be an agreement, which has been mutually agreed by all the parties involved.

The agreement must be such that all the profits of the business shall be equally shared (if the deed is silent over it).

The business must be carried on by either any person, acting on behalf of all, or all the persons involved.

It is necessary that the aforementioned three terms shall be satisfied, so that a group of associates can be held to be partners.[4] The Third element is extremely important. It essentially means that the person or the group of persons who, as agent(s) conduct the business, shall be liable, for all.[5] It also emphasises that the relationship shared by a partner with a firm is not that of a master and servant, but rather a relationship based on the concept of equality.

3. Determination of the existence of Partnership

This is classified in 4 sub-categories:

3.1 Eligibility to form a partnership:

Under section 2(6-B) of the Income Tax Act, it has been clearly stated that, “inter alia, firm and partnership have the same meaning respectively as they have in IPA.” Further S.4 of IPA, mentions that a firm is not an entity or person, but merely an association of individuals and a firm name is only a collective name of those individuals who constitute the firm.

This was critically analysed in Dulichand Laxminarayan v. Commissioner of Income tax, Nagpur.[6] Here the court established that an agreement signed by the karta of a Hindu family does not qualify as a representation of a firm. This was a significantly valuable development in jurisprudence. The judgement of the Nagpur High Court overlooked the recommendations of the seventh report on Partnership Act 1932, where in it was held that the karta can enter into a partnership, and this does not require any special provisions.

Further in Deputy Commissioner of Sales Tax v. KK Kelukutty,[7] the court rightly held that each partnership can be a distinct and separate partnership and thus a “distinct and separate firm” meaning that each partnership is in itself a distinct relationship.

3.2 Shared profits and Partnership

Profit-sharing has been a key element in establishing a partnership( id 3). However, it is not the only factor in establishing a partnership.

In India, the landmark judgement by the Privy council in Mollow, March and Co.(MMC herein afterwards) v Court of Wards.[8] Here, Raja Pratap Singh had advanced an amount to a firm W.N. Watson (WN afterwards), however, the company experienced an unsuccessful venture. This led to the firm offering a profit-sharing agreement to the Raja. Later the firm entered into a contract with MMC and is again unable to fulfil the contract. MMC brought a suit of non-performance against the Raja and WN. The privy council here established that even though participation in the “profit of trade is a strong test of partnership, there may be cases where it may as a presumption be not of law, but of facts.”

The existence of a partnership depends on the real intention and conduct of the parties, and that profit-sharing merely presents a rebuttable presumption. Deputy Commissioner of Sales Tax v. KK Kelukutty.(Obiter)

3.3 Co-Ownership and Partnership

An essential element in Partnership agreements is the intention to carry on a business. (id 3) “The mere fact that persons own something in common which produces returns does not elevate them as partners.” (Mulla).

The concept of Co-ownership does not imply a partnership. Rather, it is limited to the ownership rights of a person or a group of person(s) in a business venture. The fundamental differences between Co-ownership and Partnership, as stated by the Supreme Court are:[9]

  1. Co-ownership is not necessarily the result of an agreement, while the partnership is
  2. Profit or loss is not an inherent component of co-ownership
  3. And most importantly, while in a partnership each partner acts for all, the same cannot be construed for a co-ownership agreement.

Here, the Patna High Court, applying the black letter law concluded that it was a case of a partnership, as the profit-sharing had been decided mentioned in the deed. The Supreme Court differed from the High Court’s erroneous opinion and held that profits or losses distributed in accordance with the respective shares (as it was specified in the partnership deed) does not necessarily establish a partnership. Facts were extremely detrimental in the case, and the apex court considered the intention and surrounding facts delivered a verdict that till date is relevant in classifying a partnership from an agreement of co-ownership.

The same had been stated in SK Parthaswamy v. K Rama Naidu, where the High Court categorically stated that “profits of a trade are a strong test of partnership and there may be cases where from such a participation alone it may as a presumption, not of law but of fact, be inferred, however, it is a must that profits be considered in the light of other circumstances.” [10]

Further in India, the courts have held that ‘profit’ means an ‘investment with the aim of enhancing the income’ not a regular payment like rent. Merely receiving a regular payment, with no contribution does not amount to the formation profit.

3.4 Partnership and Service

The status of a “salaried partner” has been extremely useful for partnerships, for tax and business purposes. However, the classification between a “salaried partner”, which essentially enjoys the documentation of an employee and a partner is extremely crucial in order to ascertain the existence of a partnership.

A locus classicus in this field remains the judgement of J Megarry in Stekel v Ellice.[11] Here, Ellice, a chartered accountant, had employed Sketel as an employee and promised that “if things work out, he’ll be elevated as a partner.” However, due to issues involving past liabilities, a compromise was reached between both the parties, where Ellice promised Stekel the position of a “salaried partner” till the year 1969, after which, as per the deed he shall be elevated as a partner. Later Stekel left the firm in 1970 and brought an action wounding up the partnership. J Megarry in his judgement explicitly stated that “it is extremely important to look at the substance of the relationship between the parties in order to analyse whether a person is a partner or not. The question is of true relationship.” He goes on to state that a salaried partner on a fixed salary could be a partner if he is entitled to a share in the profits upon the winding up of a partnership. “The relationship is a question of fact, and is not determined by what the parties call it.”

In India, the precedent was set by the Calcutta High Court in the case of Munshi Abdul Latif v Gopeswar Chattoraj, wherein the court held that mere splitting of profits does not mean that there exists a partnership.[12]

4. Conduct of partners during the course of Partnership

Section 11 of the Indian Partnership Act lays down the guidelines that the partners, during the course of their partnership need to follow. Section 11(2) further delves into the agreement upholding restraint of trade during the course of the partnership, wherein the partners are not allowed to operate a business other than that of the firm while they are partners.

However, the law was limited only to the aspect of restraining the partners from dealing in a rival business venture but was silent when it came to competing in businesses of the same nature. This shortcoming of the law arose in the case of  Novartis Vaccines & Diagnostics Inc., USA v. Aventis Pharma Limited.[13] Here while the defendant contested that in absence of an express negative covenant and citing the shortcoming of Section 11(2) of the statute, he shall not be held liable.

The court, in a first of its kind laid down the guidelines concerning equity in partnership, and that further held that “Merely because there is no negative covenant, that itself is not sufficient to permit other partners to do rival or competing business of the same nature. It is a partner’s general duty to be just and faithful to the firm or company.

5. Dissolution of a Partnership

Section 39 of the Indian Partnership Act deals with the concept of dissolution of a partnership. It implies the complete breakdown of the “relation partnership amongst all the partners”.

Upon dissolution, “Asset Realization” and “Adjustment of the rights of the partners”- for liquidation purposes and its differentiation from the concept of “Sale” becomes extremely important. “Sale” according to its ordinary meaning is a transfer of property for a price. Income tax act.

In the Indian jurisprudence, this demarcation was classified in Commissioner of Income Tax v. Dewas Cine Corporation wherein the court held that a partner can, on dissolution insist that the assets of the partnership be realized by the method of sale.[14] Further, it stated that in doing so any “actual or notional sale” performed cannot be treated within the definition of sale, thereby reinterpreting the traditional definition of “Sale”.

6. Conclusion

Partnership is a widely practised concept, and through the myriad of aforementioned cases, the project has explicitly laid out the position taken by various courts in determining the existence of ‘Partnership’. A proper understanding of the nature of the partnership is extremely useful while dealing with cases revolving around concepts like service, co-ownership, profit sharing and even tax planning.  Deeds are placed higher in the hierarchy than the Law in view of the Court. The Court only primarily depends on the Law only when there is no partnership deed. Deeds are thus integral and vital to Partnership.

Endnotes

[1]Andhra Pradesh Co-operative Wool Spinning Mills Limited v. G Mahanandi and Company Wool Merchants, (2003) AS No. 1290 of 1998.

[2] KD Kamath v. CIT, (1971) 2 SCC 873 .

[3]Dulichand Laxminarayan v. CIT, (1956) SC 354

[4] Ibid.

[5] G. Bharuka, Frederick Pollock and Dinshah Fardunji Mulla, Pollock & Mulla The Indian Partnership Act (LexisNexis Butterworths 2007).

[6] Dulichand Laxminarayan v. Commissioner of Income tax, Nagpur, (1956) SCC 154.

[7] Deputy Commissioner of Sales Tax v. KK Kelukutty (1985) SCR 135.

[8] Mollow, March and Co v. Court of Wards, (1872) L.R. 4 P.C. 419.

[9] Champaran Cane Concern v. State Of Bihar, (1964) SCR (2) 921.

[10] SK Parthaswamy v. K Rama Naidu, (2001) 2 MLJ 779.

[11] Stekel v. Ellice, (1973) All ER 465.

[12] Munshi Abdul Latif v. Gopeswar Chattoraj, (1932) Cal 204.

[13] Novartis Vaccines & Diagnostics Inc,USA v. Aventis Pharma Limited, (2009) SCR 763.

[14] Commissioner of Income tax v. Dewas Cine Corporation, (1968) SCR (2) 173.


ABOUT THE AUTHOR

Ishan Khare

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Ishan is a first-year student of NUJS, Kolkata, and is extremely passionate about Constitutional and International Law.

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