Dissolving a partnership firm means discontinuing the business under the name of the said partnership firm. In this case, all liabilities are finally settled by selling off assets or transferring them to a particular partner, settling all accounts that existed with the partnership firm.

Any profit/ loss is transferred to partners in their profit sharing ratio as agreed by them in the partnership deed.

Dissolving a partnership firm is different from dissolving a partnership. In the former case, the firm ends its name and hence cannot do business in the future. But in case of dissolving a partnership, the existing partnership is dissolved by consent or on happening of a certain event, but the firm can retain its existence if remaining partners enter into a new partnership agreement.

Ways of Dissolving a Partnership Firm

There are different ways in which a partnership firm may get dissolved. They are –

When partners mutually agreed

It is the easiest way to dissolve a partnership firm since all partners have mutually agreed upon closing the partnership firm. Partners can give a mutual consent or may enter into an agreement for the dissolve. 

Compulsory dissolution

A firm may need to be dissolved compulsorily if:

• All partners or all partners except one partner are declared insolvent.
• The firm is carrying unlawful activities like dealing in drugs or other illegal products or doing business with alien countries or other countries that may harm the interest of India or doing other such activities.

Dissolution depending on certain contingent events

Upon happening of certain events, a firm may be required to get dissolved:

• Expiry of fixed-term– Partnership formed for a fixed term will get dissolved once the term gets over.
• Completion of a task– Sometimes, a partnership is formed for a certain task or objective. Once the task is completed, the partnership will automatically get dissolved.
• Death of the partner– If there are only two partners, and one of the partner dies, the partnership firm will automatically dissolve. If there are more than two partners, other partners may continue to run the firm. In such case, only the partnership will get dissolved, and other partners will enter into a new agreement.

Dissolution by notice

If a partnership business is at will, any partner can dissolve the partnership by giving advance notice. Notice will contain a date from which dissolution will be effective.

Dissolution by Court

If any of the partners become mentally unstable or misbehaves with the other partner(s) or doesn’t abide by the clauses of the agreement, the other partner(s) may file a case in the court to dissolve the firm. But a court can dissolve the firm only if it is registered with the Registrar of Firms. Hence an unregistered partnership firm can’t be dissolved by the court.

Transfer of interest or equity to the third party

If any partner transfers control in the form of interest or equity to a third party without consulting other partners, the partner(s) may dissolve the firm.

Partners still liable to third parties

Until a public notice of dissolution is given, the partners remain liable for any act done by any of the partners which would have been an act of the firm, if such act was done before resolution.

If a partner has been declared insolvent or has retired from the firm, he will not be liable for any acts done after his insolvency or retirement. The legal heirs of any deceased partner are also not liable for any acts done by other partners after the partner has died.

How are accounts settled

Accounts of the firm are settled in the following order–

• Losses of the firm will be paid out of the profits, next out of the capital of the partners, and even then if losses aren’t paid off, losses will be divided among the partners in profit sharing ratios.
• Assets of the firm and the capital contributed by the partners to set-off losses of the firm will be applied in the following order–
  
  • Third party debts will be paid first.
  • Next, the loan amount taken by the firm from any partner will be repaid to that partner.
  • Capital contributed by each partner will be repaid to him in the capital contribution ratio.
  • The Balance amount will be shared among the partners in their profit sharing ratios.
• Upon realization, all assets will be sold off in the market, and the cash realizing out of such a sale will be used for paying the liabilities. Assets or liabilities may also be taken over by the partner(s) for which the respective partner capital accounts will be adjusted by such amount.

Premium to be returned on premature dissolution

If a partner paid a certain premium for entering into a partnership for a fixed term, and the firm is dissolved before the end of the fixed term, the firm is liable to repay the partner his premium amount. But few conditions are attached with this –

• The firm is not dissolving due to the death of a partner.
• Dissolution should not be happening due to his misconduct.
• Dissolution is happening on the basis of an agreement that contains no provision for repayment of full or a part of the premium.