Central University of South Bihar

School of Law and Governance

CONTRACT-II

Project Work on the Topic – CHANGE IN THE

PARTNERSHIP/RECONSTITUTION OF THE FIRM

Under the supervision of – Dr. ANANT PRAKASH NARAYAN

Central University of South Bihar,Gaya

Submitted by :-
SHASHANKA
B.A LL.B (2018-2023)
E. No. – CUSB1813125093
School of Law and Governance

CONTRACT-II Page 1
 TABLE OF CONTENT

Sr. No Page No.

1. Abstract ………………………………………………………….…..03

2.Introduction………………….……………………………………....04

3. Inclusion of partner…………………………………………………….…..06

4. Retirement of partner…………………………………… ………………....08

5. Expulsion of partner…………………………………………………….….10

6. Insolvency of partner.…………………………………………….…..……...11

7. Liability of estate of deceased partner ………………………………………12

8. Rights of outgoing partner to carry on competing business……………….…13

9.Rights of outgoing partner in certain cases to share subsequent profits………13

10.Conclusion…………………………………………………………………….15

11.End note………………………………………………………………………16

12.References……………………………………………………..……………….17

CONTRACT-II Page 2
 ABSTRACT

Partnership is an agreement between two or more persons (called partners) for sharing the
profits of a business carried on by all or any of them acting for all. Any change in the existing
agreement amounts to reconstitution of the partnership firm.This results in an end of the
existing agreement and a new agreement comes into being with a changed relationship
among the members of the partnership firm and/or their composition. However, the firm
continues. The partners often resort to reconstitution of the firm in various ways such as
admission of a new partner, change in profit sharing ratio, retirement of a partner, death or
insolvence of a partner. In this chapter we shall have a brief idea about all these and in detail
about the accounting implications of admission of a new partner or an on change in the profit
sharing ratio.

Reconstitution of partnership takes place when there is any change in the partnership i.e.
business, profit sharing ratio, office address etc. signed in the existing deed. These changes
can be constituted in the existing partnership by drafting supplementary deed with proper
franking and notarization on the same.

Following are some occasions where reconstitution of partnership can take place:

1.When there is change in profit sharing ratio

2.When a new partner is admitted to the firm

3.There is retirement of the existing partner

4.In case of death of the partner

5.When there is amalgamation, merger or demerger of the firms

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 INTRODUCTION

RECONSTITUTION OF THE FIRM

Reconstitution of a partnership refers to a situation when there is a change in the existing

partnership agreement. A Partnership agreement is an agreement between two or more
persons for carrying out various business activities. In case of reconstitution, a new
partnership agreement is formed to replace the old partnership agreement. It means the firm
continues to exist and the only change will take place in existing partnership agreement.
Thus, the cases such as admission of a new partner, death / retirement / insolvency of a
partner, change in profit sharing ratio, etc., leads to a reconstitution of partnership.

Reconstitution involves only a change in the relationship of the partners of a business but in
the case of dissolution of the firm there is a complete discontinuation in the relationship of
the partners of a firm. Dissolution of a partnership can be dome under circumstances not just
voluntarily. It can be dissolved under a mutual agreement when all partners agree to it and it
is in accordance to the contract. It can be dissolved by giving a legal notice and under law.
When there is a breach of terms and conditions by one partner than partnership can be
dissolved. Also when the court gives out a notice it has to be dissolves. (MATHUR, 2010)

Partnership agreement defines the relationship among the partners and whenever there is
change in relationship, it results in reconstitution of the firm. Such reconstitution of the firm
always leads to change in profit-sharing ratio among the partners. A firm is reconstituted,
whenever there is a:

i.Change in the profit-sharing ratio among the existing partners.

ii.Admission of a new partner

.iii.Retirement of an existing partner.

iv.Death of a partner.v.Amalgamation of two or more partnership firms.

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New Profit Sharing Ratio

New profit sharing ratio is the ratio in which the remaining partners will share future profits
after the retirement or death of any partner.The new share of each of the remaining partner
will consist of his own share in the firm plus the share acquired from the retiring /deceased
partner.

Consider the following situations :

(a) normally, the continuing partners acquire the share of retiring or deceased partners in the
old profit sharing ratio, and there is no need to compute the new profit sharing ratio among
them, as it will be same as the old profit sharing ratio among them. In fact, in the absence of
any information regarding profit sharing ratio in which the remaining partners acquire the
share of retiring/deceased partner, it is assumed that they will acquire it in the old profit
sharing ratio and so share the future profits in their old ratio. For example, Asha, Deepti and
Nisha are partners in a firm sharing profits and losses in the ratio of 3:2:1. If Deepti retires,
the new profit sharing ratio between Asha and Nisha will be 3:1, unless they decide
otherwise.

(b) The continuing partners may acquire the share in the profits of the retiring/deceased
partner in a proportion other than their old ratio, In that case, there is need to compute the
new profit sharing ratio among them,

Gaining Ratio

The ratio in which the continuing partners have acquired the share from the retiring/deceased
partner is called the gaining ratio.Normally, the continuing partners acquire the share of
retiring/deceased partner in their old profit sharing ratio, In that case, the gaining ratio of the
remaining partners will be the same as their old profit sharing ratio among them and there is
no need to compute the gaining ratio, Alternatively, proportion in which they acquire the
share of the retiring/deceased partner may be duly spacified. In that case, again, there is no
need to calculate the gaining ratio as it will be the ratio in which they have acquired the share
of profit from the retiring deceased partner. The problem of calculating gaining ratio arises
primarily when the new profit sharing ratio of the continuing partners is specified. In such a
situation, the gaining ratio should be calculated by, deducting the old share of each

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continuing partners from his new share. For example, Amit, Dinesh and Gagan are partners
sharing profits in the ratio of 5:3:2. Dinesh retires. Amit and Gagan decide to share the profits
of the new firm in the ratio of 3:2.

Treatment of Goodwill

The retiring or deceased partner is entitled to his share of goodwill at the time of
retirement/death because the goodwill has been earned by the firm with the efforts of all the
existing partners. Hence, at the time of retirement/death of a partner, goodwill is valued as
per agreement among the partners the retiring/ deceased partner compensated for his share of
goodwill by the continuing partners (who have gained due to acquisition of share of profit
from the retiring/ deceased partner) in their gaining ratio.The accounting treatment for
goodwill in such a situation depends upon whether or, not goodwill already appears in the
books of the firm.

INCLUSION OF A PARTNER(SEC.31)

When a firm requires additional capital or managerial help it can admit a new partner in its
business. As per the Partnership Act, 1932, a new partner can only be admitted unanimously
unless otherwise provided in the partnership deed. When a new partner is admitted a new
agreement is formed and thus the firm is reconstituted. The new partner acquires the right to
share the assets of the firm for which he brings in the capital and the right to share the future
profits of the firm for which he brings Goodwill. On admission of a new partner, the profit
sharing ratio changes, the assets and liabilities are revalued and goodwill is calculated and
distributed among the old partners in their sacrificing ratios.Admissions leads to
reconstitution of firms as the existing agreement comes to an end and a new agreement comes
into effect. A new partner may be admitted for increasing the capital, augmenting managerial
skills, etc rights of new partner are right to share assets of the firm and to share of profit from
the old partners which reduces their share of profits. Hence, it becomes necessary to calculate
the new profit sharing ratio.

Sacrificing ratio is the ratio in which the old partners sacrifice their share of profit in favour
of the new partner. If new partner brings premium for goodwill, such premium should be
disturbed among the existing partners. If new partner brings premium for goodwill, such

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premium should be distributed among the existing partners. If new partner is unable to bring
premium for goodwill, his share of goodwill is adjusted through partners’ current accounts or
capital accounts new partner does not suffer because of reduction in the value of assets, nor
should not he be benefitted by increase in the value of assets. Hence, profit or loss on
revaluation is divided among the old partners in the old profit sharing ratio. Sometimes, it is
desired by all the partners that revised values of assets and liabilities should not be shown in
new balance sheet. So, Memorandum revaluation account is prepared. Reserves and
accumulate profits/losses should be transferred to the old partners capital accounts in their old
ratio. There can be three type of situations that require the adjustment of capital . the capitals
of old partners may be adjusted by taking new partners’ capital as base, the new partner may
be required to contribute the proportionate capital considering old partners’ capitals as base
or capital of the new firm is given in the question and capital of all the partners is to be
according to profit sharing ratio.

When can a partner be admitted to a partnership firm?

A person may be admitted as a new partner—

(i) in accordance with the Partnership Deed.

(ii) with the consent of all the existing partners,

Liability of an Incoming partner:

The liabilities of a new partner in a partnership firm generally commences from the date
when the individual is admitted as a partner unless he agrees to be liable for obligations
incurred by the firm before the date. The new firm, including the newly introduced partner
who joins it, may agree to assume liability for the firm’s existing debts, and creditors may
decide to accept the new firm as their debtor and discharge the old partners. The consent of
the creditor is necessary in every case to make the transaction operative. Novation is the
technical term in a contract for substituted liability, of course, not confined only to the case of
a partnership. But a simple agreement among the partners cannot operate as Novation. Thus,
an agreement between the partners of the firm and the incoming partner stating that he shall
be liable for existing debts will not ipso facto give creditors of the firm any right against him.

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In the case of a partnership between two partners, this section does not apply as the
partnership automatically dissolved by the death of one of them. In this event, there is no
partnership at all for any new partner to be introduced into it without the consent of other.

A new partner admitted into a firm is not liable for any act of the firm done before his
admission .However, an incoming partner may, by an agreement, agree to become liable for
the acts done before his admission, provided:

(a) The newly constituted firm has agreed to pay the debts, and

(b) The creditors have agreed to accept the new firm as their debtor and discharge the old
firm from its liability.However, the position will be different, if a minor partner on attaining
majority elects to become partner. In this case, a minor partner on attaining maturity shall be
liable for all acts of the firm done since he was admitted to the benefit of the partnership and
not from the date he becomes a major.

RETIREMENT OF A PARTNER [Sec. 32]

Another reason for the reconstitution of a firm is when partner wants to get retirement.
Partner can be retired when he/she gets the consent of all other partners. It is clearly stated
Partnership gives the notice to the partners if they have to get retirement. The methodology
through which partners can get retirement is precisely mentioned in an agreement. Another
point which cannot be missed is that the partner who is going to be retired has to give notice
to the public about his decision in order to obtain freedom from liability of the debts of the
firm. (Saeed, 2012)

A partner may decide to retire or withdraw from the firm due to reasons such as his age, his
bad health, change in firm’s nature of a business, etc. In case of Partnership at Will, a partner
may retire at any time. Retirement amounts to a reconstitution of a firm where the number of
partners, their capital contribution ratio and also the profit sharing ratio changes. The retiring
partner is paid his share of capital, goodwill and revaluation profit or loss.

When can a partner retire from a partnership firm?

A partner may retire—

(i) in accordance with the Partnership Deed, or

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(ii) with the consent of all the other partners, or

(iii) where the partnership is at will, by giving notice in writing to all the other partners of his
intention to.

Liability of a Retired Partner:

For the Acts done before retirement: Even after retirement, a partner continue to be liable for
all the acts of the firm done before his subject to a contract to the contrary, he will not—

(a) Use the firm name,

(b) Represent himself as carrying of the business of the firm, or

(c) Solicit the custom of persons, who were dealing with the firm before he ceased to be a
partner.

2. To Share Subsequent Profits (Sec. 37):

Where the other partners carry on the firm’s business without making a final settlement of the
outgoing partners, then

in the absence of any agreement, the outgoing partner or his legal representative shall be
entitled to, at his option, to—

(i) Such share of the profits as is proportionate to his share in the property of the firm, or

(ii) interest @ 6%p.a. on the amount of his share in the property of the firm.

For example, X, Y, and Z are partners in the firm sharing profits in the ratio of 3:2:1. X
chooses to retire and Y and Z decide to share the future profits equally. This is a
reconstitution of the firm where the number of partners and their profit sharing ratio both
have changed.

EXPULSION OF A PARTNER [Sec. 33]

When can a partner be expelled from a partnership firm?

A partner may be expelled from partnership subject to the

following three conditions:

(1) The power of expulsion of a partner should be conferred by the Partnership Deed.

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(2) The power should be exercised by a majority of the partners.

(3) The power should be exercised in good faith. The following three criteria are the test of
good faith—

(a) The expulsion must be in the interest of the partnership,

(b) A proper notice is served to the expelled partner,

(c) He is given an opportunity of being heard.

What is irregular expulsion?

If a partner is expelled without complying with the above conditions, the expulsion is called
irregular. In such a case,

the expelled partner may—

(1) Claim re-instatement as a partner, or

(2) sue for the refund of his share of capital and profits in the firm.

In short, in the case of irregular expulsion, the partner does not cease to be a partner. It is
wholly inoperative. Further,irregular expulsion does not give right to damage to expelled
partner.

In s.vel arvind and others vs radhakrishnan and others,(2018) 4 MLJ 468, the madras high
court has clarified,in paragraph 15,that, “in the absence of explicit provisions in the contract
agreed to between the partners regarding expulsion of partners, only remedy available to the
disgruntled partners is taking recourse to section 44 of the Indian partnership act for
dissolution to be ordered by the court on a suit of the partner and they cannot dismiss or expel
the other partner”

CAUSES OF EXPULSION OF A PARTNER

Expulsions takes place due to some reasons which include misconduct, dishonesty, unethical
act, insolvency. Misconduct usually involves individual committing material or persistent
breaches of the partnership member’s agreement or willfully neglecting to abide by any of
his/her responsibilities. When individual commits crime he is dishonest. A partner cannot be
in partnership anymore as soon as he is adjudged an insolvent. (SILKIN, 2012)

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 INSOLVENCY OF A PARTNER [Sec. 34]

Insolvent means that when one person is failed to pay its debts. Reconstitution of a firm
happens when partner becomes insolvent. A partner can become insolvent on two bases. First
of all partnership business is going and when partnership is going too dissolved. Partners
have to declare it officially or get it signed by many people when they want insolvency of a
partnership. (BATASNATIN.COM)

Under section 51 of partnership act, when partner is declared guilty of insolvency on the basis
of petition of the partners or any one partner initiated, petition of more than three creditors in
the partnership qualified as provided in section twenty of the act.(PARTNERSHIP ACT,
1932)

Insolvency of a partner also results in the reconstitution of the firm when the remaining
partners wish to continue the firm. In case of insolvency, all dues are paid to the insolvent
partner and partnership agreement is aborted because as per the law an insolvent is
incompetent to enter into a contract or an agreement.

Section 34(1) of the act states that if any partner of a partnership firm has been adjudicated as
insolvent by the competent authority/court ,he/ she ceases to remain partner in the partnership
firm from the date of order of adjudication

Section 34(2) of the act clarifies that the insolvent partner’s estate shall not made liable for
the firm’s acts which are done after the date.

The legal effects of insolvency of a partner are as follows:

(1) Where a partner in a firm is adjudicated insolvent, he ceases to be a partner on the date on
which the order a adjudication is made.

(2) The firm is dissolved on the date of the Order of adjudication, but the partners may
specifically provide that on such a contingency, the firm shall not be dissolved.

(3) The estate of the insolvent-partner is not liable for the acts of the firm done after the date
of the order of adjudication. A public notice to the effect that a partner has been adjudicated
insolvent is not required.

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(4) The firm is also not liable for any act of the insolvent partner after the date of the order of
adjudication.

LIABILITY OF ESTATE OF DECEASED PARTNER(SEC.35)

Where under a contract between the partners the firm is not dissolved by the death of a
partner, the estate of a deceased partner is not liable for any act of the firm done after his
death.

In a case where under a contract that the death of a partner does not dissolve a firm, the
estates of the deceased partner are not liable for any act of the firm after his death.

Generally, the effect of the death of a partner would result in the dissolution of the
partnership. Although the rule in concern to the dissolution of the partnership due to death of
a partner is subject to a contract between the parties and the partners are competent to agree
that the death of a partner will not have the effect of dissolving the partnership. This is
applicable unless the firm consists of just two partners. It is not essential to give any notice
either to the public or the individuals who have dealt with the firm about the estate of the
deceased partner may be absolved from liability from future obligations of the firm.

RIGHTS OF OUTGOING PARTNER TO CARRY ON COMPETING

BUSINESS

Section 36 (1) of the Indian Partnership Act, 1932 (Partnership law), imposes certain
restrictions but allows an outgoing partner to carry on a business and advertise it, which
competes with the partnership firm. However, it restricts him from:

i)Using the name of the partnership firm

ii)Representing himself as a partner of the firm

iii)Soliciting the custom of persons who were dealing with the firm before he ceased to be a
partner.

Section 36 (2) talks about an agreement in restraint of trade. According to this subsection, an
outgoing partner may make an agreement with his partners that when he ceases to be a
partner of the firm, he will not carry on any business similar to that of the firm within a

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specified period or local limits. This is notwithstanding anything contained in Section 27 of
the Indian Contract Act, 1872.

RIGHTS OF OUTGOING PARTNER IN CERTAIN CASES TO SHARE

SUBSEQUENT PROFITS

According to Section 37, of the Partnership Law, if a member of the firm dies or otherwise
ceases to be a partner of the firm, and the remaining partners carry on the business without
any final settlement of accounts between them and the outgoing partner, then the outgoing
partner or his estate is entitled to share of the profits made by the firm since he ceased to be a
partner.The share may be attributable to the use of his share of the property of the firm or the
interest at six percent per annum on the amount of his share in the property.

The surviving partners also have an option of purchasing the interest of the deceased or
outgoing partner. If the surviving partners choose to purchase the interest, then the outgoing
partner is not entitled to any further share in profits of the firm.

Example

Peter, John, and Oliver are partners in a shirt manufacturing company. Peter is entitled to
three-eighths of the partnership property and profits. After a couple of years of business,
Peter becomes bankrupt while John and Oliver continue the business without paying out
Peter’s share of the firm’s assets or settling accounts with his estate. Does Peter get a share of
the profits?

Answer: Yes. Peter is entitled to three-eighths of the profits made in the business from the
date of his bankruptcy until the final liquidation of the partnership affairs.

Peter, John, and Oliver are partners in a travel company. Oliver retires after selling his share
in the partnership firm. However, Peter and John fail to pay the agreed value of the share to
Oliver. Can Oliver recover the amount?

Answer: Yes. The value of Oliver’s share on the date of his retirement from the firm will be
pure debt on the firm. This debt will be applicable from the date on which he ceased to be a
partner of the firm as per the agreement between him and his partners. He can recover his
share amount along with the interest

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REVOCATION OF CONTINUING GUARANTEE
Section 38 :

The section, lays down that a continuing guarantee given to a firm, or to a third party in
respect of the transactions of a firm is in the absence of agreement to the contrary, revoked as
to future transactions from the date of any change in the Constitution of the firm

Case law:

N.C.MUKHERJEE VS BIRO DAS

In this case 'A' was a surety to the firm "N.C. Mukherjee" for the conduct of B, a cashier in
the firm of N.C. Mukherjee. Later on a change took place in the Constitution of the firm and
its name was altered to "N.C. Mukherjee & Sons". It was held that surety was not liable for
B's defamations subsequent to the change in the Constitution of the firm

Effect of change –

Section 38 deals with the effect of the change in the Constitution of a firm on continuing
guarantee and provides that any change in the Constitution of a firm will have the effect of
revoking a continuing guarantee given to that firm or to a third party in respect of transactions
of a firm, from the date of change in the Constitution of the firm, unless there is an agreement
to the contrary. The provision of this section is based on established rule that any change in
the Constitution of a firm without the consent of surety will alter risk of surety. The rule laid
down in the section is that change in the Constitution of the firm will have effect of revoking
as To a future transactions any continuing guarantee that may have been given to the firm or
to a third party in respect of any transaction of the firm unless there is agreement to the
contrary.

"Continuing guarantee." -- The expression "continuing guarantee" has been defined in

section 129 of the Indian contract Act as follows :
"A guarantee which extends to a series of transactions is called continuing guarantee." This
continuing guarantee may be revoked. Section 130 of Indian contract Act deals with the
revolution of continuing guarantee and provides that "A continuing guarantee may at any
time be revoked by the surety as to future transactions, by notice to the creditor."

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 CONCLUSION

We can conclude that As a reconstituted partnership, the business does not need a new TFN
and ABN, and only one partnership tax return is required covering the full income year. For
the purposes of the GST, the partnership does not need new GST registration (where the
partnership was already required to register).

Generally, the Tax Office will treat a changed partnership as a reconstituted partnership, and
the following factors apply:

 the partnership is a general law partnership (as opposed to a tax law partnership;
contact us if you are unsure of the difference)a
 at least one of the partners is common to the partnership before and after
reconstitution
 the partnership agreement includes an express or implied continuity clause
 there is no break in the continuity of the enterprise or firm (the partnership’s assets
remain with the continuing partnership and there are no changes to the nature of the
business, the customer or customer base, the business name or name of the firm)
 there is no period where there is only one partner (in a two-person partnership, there is
a direct transfer of interest from the outgoing partner to a new partner).

Note that a two-person partnership can be reconstituted. This may occur where a partner dies,
and the partnership agreement allows for continuity of the partnership with either the
executor, trustee or beneficiary of the deceased partner’s estate. The continuity clause may be
express, or implied by way of conduct. Where this happens, and the firm continues without
any break in the continuity of the enterprise, the Tax Office generally considers there is a
change in members and that the entity is a continuing reconstituted partnership.

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 ENDNOTE

1. DUSHASAN SAHOO & ANR VS KENEILHOUSE ANGAMI AIR 1987

2. Manilal Jamnadas (Seeds) vs Commissioner Of Income-Tax AIR 1980
3. S.Lakshmi vs M/S Reliance Builders, Hyderabad AIR 2009
4. Manilal Jamnadas (Seeds) vs Commissioner Of Income-Tax AIR 2011
5. Shri Ramesh Prasad Sao vs Union Of India Through Secretary AIR 1982
6. Smt.Jharna Sao & Ors. vs Sri Sheo Shankar Prasad Sao AIR 2008
7. State By Registrar vs Sri Santosh S.Lad AIR 1997
8. Vishwanath Seth vs Commissioner Of Income-Tax AIR 1980
9. Bharat Sarvodaya Mills Co. Ltd. vs Mohatta Brothers AIR 1995
10. M/S. Nirmal Lotteries vs Dda & Another AIR 2006
11. Capt. Manmohan Singh Kohli vs Venture India Properties P. Ltd AIR 2009
12. The I.T.O., Ward 22(10) vs Smt. Paru D. Dave AIR 1981
13. M/S Bharat Catering Corporation vs Indian Railway Catering AIR 1985
14. G. Janobai vs V.N. Devadoss AIR 1984
15. Malini Rao vs Hotel Dwaraka And Ors AIR 1989

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 REFERENCES

1.BANGIA, R. K. ‘CONTRACT-II.’(2010)
2. KAPOOR, S.K. “CONTRACT-II.”(2005)

3.SINGH, AVATAR“ INTRODUCTION TO LAW OF PARTNERSHIP”(2005)

4. MALLIC, M.R. “THE LAW OF PARTNERSHIP”(2006)

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