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How to Establish a Partnership Firm?

Last revision:
Last revision: July 12, 2021
Last revision:
Category: Business Formation and Structure
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If you are planning to start a partnership firm, this guide is for you. In India, partnerships are regulated and controlled under the provisions of the Indian Partnership Act, 1932. Unlike a company or Limited Liability Partnership (LLP), a partnership firm is easy to form and has fewer legal compliances. All the partners share a portion of partnership profits and losses. Under the partnership, each partner individually termed as a "Partner" and collectively as a "Firm". The basic requirement of a partnership firm is to have a well-drafted partnership deed.

What is a partnership firm?

A partnership or partnership firm is an arrangement between two or more parties to manage and operate a business and share its profits. The business you are doing under the partnership has to be legal. The partnership firm is different from that of an LLP under which the liability of partners is limited to their contribution to the partnership. The form an LLP, you need to draft an LLP Agreement and get it registered. The parties to a partnership can be individuals, companies, government, NGO's, etc.

Important features of a partnership firm

1. Partners

It is necessary to have two or more eligible persons enter into a partnership. If your partnership is related to the banking business, the maximum allowed number of partners is 10 and for other types of businesses, it is 20. The partners have to be competent enough to enter into a legal agreement. The persons such as minors, lunatics, insolvent or barred under any law from entering into an agreement are not eligible to directly become a partner.

2. Partnership Deed

The partnership can be formed on the basis of an oral or written agreement. It is always better to have a written partnership deed to avoid any disputes in the future. A partnership deed with valid stamp duty is the foundation of a partnership firm. Under the partnership deed, the details including the purpose of business, details of partners, duties and obligations of partners, etc. will be included.

3. Registration

Registration of a partnership firm is optional under the Indian Partnership Act, 1932. If the partnership is not registered under the respective RoF (Registrar of Firm) the partnership cannot initiate an action in the court of law against any other parties for settlement of claims. Even if any disputes arises between you and other partners you cannot refer or resolve the dispute through a court of law. Thus, to protect the interests of both the partners and the partnership firm, it is better to get the partnership firm registered under the concerned RoF by paying the requisite fees mentioned by the concerned states.

4. Agency relationship

Comparing to other forms of businesses like companies or LLP, the partners in a partnership have agency relationships with each other. The actions which are done by a partner in good faith and on behalf of the partnership is binding on the partnership and all partners shall be liable to such actions.

5. Unlimited liability

The liability of each partner in a partnership is unlimited. All partners are jointly and severally responsible for all activities carried out of the partnership. In case, if the assets of the partnership firm are not sufficient to meet the liabilities, the assets of partners or any one of the partners can be attached to meet such liabilities.

Important clauses under the partnership deed

1. Name and address of the firm and partners

The name of the Firm has to be unique to avoid any disputes in the future. The name used for the partnership shall not infringe any trademark or use any word which denotes the connection with any government entity. To ensure that no one else using the name or have been registered as a trademark the same can be checked on the MCA website and trademark search respectively. The address of the Firm can be either an office address or a residential address. For registering the firm, proof of such address needs to be submitted at the office of the Registrar of Firms (RoF). The name and address of each partner also need to be included under the partnership deed.

2. Nature, term and purpose of business

Under the partnership deed, you can describe the nature and purpose for which the Firm is formed. A Firm can only be formed for a legitimate purpose. The term of partnership can be till a specific date, till the completion of specific milestones or projects or at the will of partners. If the Firm is created at the will of the partners, the Firm will continue to exist until the partners terminate the partnership as mentioned under the partnership deed.

3. Capital contribution and ownership information

The contributions made by each partner such as money, goods, service, etc. can be mentioned under this clause. The details of such contribution can be mentioned under the partnership deed to avoid any disputes in future. In most cases, the capital and ownership in a partnership may be proportionate to each other. But, there may be a situation where the capital contributed and ownership is not proportionate to each other. Such details can be specified under the ownership clause of the partnership deed.

4. Proft and loss sharing

The profit and loss sharing of each partnership may vary with nature and type of partnership. The profit or loss sharing ratio may on the basis of equal shares, in proportion to capital contributed, in proportion to the ownership, fixed percentage, or such alternative methods agreed by the partners at the time of entering into the partnership deed.

5. Interest on capital or loan

In some cases, the partners may be entitled to interest on capital or additional capital contributed to the Firm or any drawings made by the partners from the accounts of the Firm. Sometimes, the Firm may lend money to a partner for a short period, whether interest is applicable on such transaction can also be mentioned under the partnership deed. Thus, it is better to clarify whether such interests are applicable and if yes, the percentage of interest and other details in the partnership deed.

6. Salaries or commission to the partners

All partners may not be actively working for the Firm. Thus, as remuneration, the Firm may provide salary or commission to such working partners. It is better to mention the amount of remuneration and eligibility of the same in the partnership deed.

7. Audit and accounting procedures

Under the partnership deed, the partners can specify the type and accounting standards to be followed. The accounts can be kept on a mercantile basis under which the records are updated as and when the profits are made or costs are incurred or it can be on a cash basis under which the records are updated only when the money actually received or paid. The details of annual reports if any has to be prepared by the Firm can also be mentioned under the partnership deed.

Even though it is not compulsory for a partnership to do audits, most of the partnership firms do audit their accounts for internal checking. Under the partnership deed, the interval of such auditing can be mentioned. The partners can also mention the details of the auditor who will be appointed to audit the accounts of the Firm.

8. Management of partnership

The management of daily affairs of the Firm can be done by all partners together or through a designated managing partner. The managing partner appointed shall be liable to conduct the business in accordance with the terms of the partnership deed, keeping the accounts accurately in a timely manner, preparing the necessary reports to inform other partners about the current status of the Firm. Other specific rights and duties of the managing partner can be specified under the partnership deed.

9. Duties and obligations of partners

A partner in a Firm has certain duties and obligations towards the Firm and other partners. Compliance with these duties is paramount in the existence and smooth functioning of a partnership firm. The duties of partners include not getting involved with the business that is directly competing with the Firm without the prior permission of other partners, work for the growth and development of the firm, disclose any information related to the firm to the other partners, complying with the terms of partnership deed and indemnifying other partners from any liability arising out of or relation to the breach of terms of the partnership deed.

10. Procedures for admitting or introducing a new partner

You can mention whether a partner can be admitted to the firm after entering into the partnership deed. If yes, the voting support required (majority vote or unanimous vote) can be specified under the partnership deed. Such a new partner will be liable to agree and comply with the partnership deed and any additional conditions mentioned under the admitting agreement of such partner.

11. Procedures at the time of retirement or death of any partner or dissolution of the firm

It is important to mention what happens to the Firm if a partner retires or dies. The partnership deed includes the details like voluntary and involuntary retirement procedures for partners. A partner can voluntarily retire from the partnership by serving the notice period mentioned under the partnership deed. The involuntary retirement of a partner happens when the partner is no more eligible to continue as a partner due to mental or physical disability, legal restrictions or the death of such partner. In either case, whether the Firm continues to exist or not and how the interests of the retired or deceased partner will be handled can be mentioned in the partnership deed. At the time of retirement of a partner, to settle the accounts of the retiring partner and to mention the changes in partnership structure you can enter into a Deed of Retirement from Partnership.

The partners can decide how the firm can be dissolved (majority vote or unanimous vote) if the partnership is created at will. In case if the Firm is getting dissolved (closed down), each partner will have to share the assets and liabilities as mentioned under the partnership deed.

Registration procedure of a partnership firm

The registration of the partnership firm is optional. But considering the advantages of a registered firm, it is always better to get the partnership registered under the concerned Registrar of Firms (RoF) in the concerned state. The Firm can only initiate legal proceedings against any other parties for settlement of claims only if it is registered. The Firm or other partners also cannot settle their disputes in a court of law, if the Firm is not registered. Thus, it is always better to get the partnership firm registered under the concerned RoF by paying the requisite fee to have legal protection for both the partners and the Firm. Following are the important steps or procedures to register a Firm:

1. Partnership Deed

The first step is to have a well-drafted partnership deed with all important clauses mentioned under the Partnership Act, 1932. Such partnership deed needs to be printed on stamp paper with the stamp value of the concerned state.

2. Signing and Notarizing

Once the partnership deed is drafted and printed on a stamp paper, the partnership deed needs to be signed by all partners in the presence of two independent witnesses. After that, you need to get the partnership deed notarized by a public notary. It is necessary to get the partnership deed notarized to get it registered.

3. Registration with Registrar of Firms

You need to submit all necessary documents including Form-1, a notarized copy of the partnership deed, proof of address of all partners, proof of office address, along with the affidavit to get the Firm registered. The date of registration will be the date recorded on the Register of Firms.

Conclusion

Thus, comparing to other forms of business forms like LLP or a Company, a partnership firm is easy to start and have fewer legal compliances. The first and foremost thing to start a partnership firm is to have a well-drafted partnership deed with all-important clauses mentioned under the Partnership Act, 1932. Even though the registration is optional, it is always better to get the Firm registered under the RoF to have legal protection in the case of any disputes.

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